Publications | Ric Colacito

Volatility (Dis)Connect in International Markets

Management Science (2026)

Key Insight: Foreign exchange markets are disconnected from fundamentals in levels, but far less so in volatility.

Why it Matters: Volatility provides a missing link between macroeconomic risks and exchange rates, offering a new way to evaluate international risk-sharing models.

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Lack of co-movement between consumption growth differentials and real exchange rates is a traditional indicator of a disconnect of foreign exchange markets from economic fundamentals (Backus-Smith 1993 anomaly). We present novel evidence for the (dis)connect between the volatilities, as opposed to the levels, of these variables. The volatility correlations are below one, but they are larger than the level correlations. In the cross-section of countries, the volatility disconnect weakens for countries with low amount of expected growth risk and high amount of volatility risk. We provide an explanation of our empirical findings based on international risk-sharing of both expected growth and volatility news shocks. (with Croce, Liu, and Shaliastovich)

Global Sales, International Currencies and the Currency Denomination of Debt

Journal of Financial Economics (2025)

Key Insight: Firms’ debt currency choices closely follow the geography of their sales, but with strong tilts toward their home currency, the U.S. dollar, and the euro.

Why it Matters: The currency denomination of corporate debt reflects both hedging motives and the global role of dominant currencies in international finance.

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We document that the currency denomination of the debt of large firms in developed countries is strongly associated with the geographical distribution of their sales. Furthermore, those firms exhibit significant home currency bias and international currency bias in borrowing: controlling for the geography of sales, they borrow more in their home currency and the two most traded currencies, the US dollar and the euro. We also show that the firms’ debt currency denomination choices are associated with export invoicing currency patterns in a way consistent with a currency hedging mechanism. In particular, firms domiciled in countries that invoice a larger share of their exports in either their home currency or in a vehicle currency exhibit a weaker connection between the currency denomination of their debt and the geography of their sales. Moreover, firms in countries that invoice more of their exports in an international currency are characterized by stronger international currency bias in debt issuance. (with Y. Qian and A. Stathopoulos)

Concealed Carry

Journal of Financial Economics (2023)

Key Insight: Returns to both short- and long-maturity bond carry strategies reflect changing exposures to global growth and inflation risks.

Why it Matters: Carry trade performance depends on the macroeconomic environment, helping investors understand when and why different fixed-income strategies succeed or fail.

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The slope carry consists of taking a long (short) position in the long-term bonds of countries with steeper (flatter) yield curves. The traditional carry is a long (short) position in countries with high (low) short-term rates. We document that: (i) the slope carry risk premium is negative (positive) in the pre (post) 2008 period, whereas it is concealed over longer samples; (ii) the traditional carry risk premium is lower post-2008; and (iii) there has been a sharp decline in expected global growth and global inflation post-2008. We connect these empirical findings through an equilibrium model in which investors price news shocks, financial markets are complete, and countries feature heterogeneous exposure to news shocks about both global output expected growth and global inflation. (with S. Andrews, M. Croce, and F. Gavazzoni)

Volatility Risk Pass-Through

Review of Financial Studies (2022)

Key Insight: Output volatility shocks are shared internationally, but their effects on consumption, exchange rates, and macroeconomic uncertainty are far from one-to-one.

Why it Matters: Understanding how volatility risk passes through across countries helps explain currency movements and the international transmission of macroeconomic uncertainty.

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We produce novel empirical evidence on the relevance of output volatility shocks for both currency and international quantity dynamics. Focusing on G-17 countries, we document that: (1) consumption and output volatilities are imperfectly correlated within countries; (2) across countries, consumption volatility is more correlated than output volatility; (3) the pass-through of relative output volatility shocks onto relative consumption volatility is significant, especially for small countries; and (4) consumption differentials volatility and exchange rate volatility are disconnected. We rationalize these findings in a frictionless model with multiple goods and recursive preferences featuring a novel and rich risk-sharing of volatility shocks. (with M. Croce, Y. Liu, and I. Shaliastovich)

Business Cycles and Currency Returns

Journal of Financial Economics (2020)

Key Insight: Currencies of countries with relatively strong business cycles earn high excess returns, largely because business-cycle strength predicts subsequent spot exchange rate movements.

Why it Matters: The paper shows that macroeconomic conditions contain pricing information for currency markets beyond standard currency investment strategies and traditional currency risk factors.

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We find a strong link between currency excess returns and the relative strength of the business cycle. Buying currencies of strong economies and selling currencies of weak economies generates high returns both in the cross section and time series of countries. These returns stem primarily from spot exchange rate predictability, are uncorrelated with common currency investment strategies, and cannot be understood using traditional currency risk factors in either unconditional or conditional asset pricing tests. We also show that a business cycle factor implied by our results is priced in a broad currency cross section. With S. Riddiough and L. Sarno.

Temperature and Growth: a Panel Analysis of the United States

Journal of Money, Credit, and Banking (2019)

Key Insight: Higher summer temperatures are systematically associated with slower state-level economic growth in the United States.

Why it Matters: The estimates imply that rising temperatures could impose meaningful macroeconomic costs even in a highly developed economy.

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We document that seasonal temperatures have significant and systematic effects on the U.S. economy, both at the aggregate level and across a wide cross-section of economic sectors. This effect is particularly strong for the summer: a 1^oF increase in the average summer temperature is associated with a reduction in the annual growth rate of state-level output of 0.15 to 0.25 percentage points. We combine our estimates with projected increases in seasonal temperatures and find that rising temperatures could reduce U.S. economic growth by up to one-third over the next century. With B. Hoffmann and Toan Phan.

The Term Structures of Coentropy in International Financial Markets

Management Science (2019)

Key Insight: Coentropy provides an entropy-based measure of international SDF codependence that captures relationships beyond conventional normal-correlation measures.

Why it Matters: The measure helps evaluate whether international asset-pricing models can match the horizon-by-horizon structure of dependence across global financial markets.

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We propose a new entropy-based correlation measure (coentropy) to evaluate the performance of international asset pricing models. Coentropy captures the codependence of two random variables beyond normality. We document that the coentropy of international stochastic discount factors (SDFs) can be decomposed into a series of entropy-based correlations of permanent and transitory components of the SDFs. We employ the cross section of G-10 countries to obtain model-free estimates of all the components of coentropy at various horizons and we show that the generalization of the long-run risk model featuring two predictable components of consumption growth rates, global disasters, and recursive preferences can account for the composition of codependence at all horizons. With F. Chabi-Yo.

Recursive Allocations and Wealth Distribution with Multiple Goods: Existence, Survivorship, and Dynamics

Quantitative Economics (2019)

Key Insight: In complete-markets economies with recursive preferences and multiple goods, equilibrium can feature a stable, non-degenerate distribution of Pareto weights.

Why it Matters: The paper clarifies when recursive risk-sharing models generate economically meaningful long-run wealth dynamics and how accurately perturbation methods can approximate them.

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We characterize the equilibrium of a complete markets economy with multiple agents featuring a preference for the timing of the resolution of uncertainty. Utilities are defined over an aggregate of two goods. We provide conditions under which the solution of the planner’s problem exists, and it features a non-degenerate invariant distribution of Pareto weights. We also show that perturbation methods replicate the salient features of our recursive risk-sharing scheme, provided that higher-order terms are included. With Croce and Liu.

Currency Risk Factors in a Recursive Multi-Country Economy

The Journal of Finance (2018)

Key Insight: Heterogeneous exposure to global long-run risk can generate systematic currency risk premia across countries.

Why it Matters: The paper provides a structural framework for understanding why carry trade returns reflect compensation for global macroeconomic risk rather than purely country-specific shocks.

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We study a risk-sharing model featuring multiple countries with recursive preferences defined over bundles of consumption goods whose supply is subject to both global and local short- and long-run shocks. First, we quantify the extent of contagion and insurance possibilities as we vary the number of countries in the economy. Second, we introduce persistent heterogeneous exposure to global long-run news shocks and analyze the properties of several carry trade strategies in the context of our model, including Lustig et al. 2011 HML-FX and Della Corte et al. 2013 HML-NA. With M. Croce, F. Gavazzoni, and R. Ready.

BKK the EZ Way: International Long-Run Growth News and Capital Flows

American Economic Review (2018)

Key Insight: Positive long-run productivity news can generate net capital outflows in developed economies, a pattern that standard international business-cycle models cannot explain.

Why it Matters: The paper shows that recursive preferences help reconcile international capital-flow dynamics with long-run growth risk and risk-sharing incentives.

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We study the response of international investment flows to short- and long-run growth news. Among developed G7 countries, positive long-run news for domestic productivity induces a net outflow of investments, in contrast to the effects of short-run growth shocks. We document that a standard Backus, Kehoe, and Kydland (1994) (BKK) model fails to reproduce this novel empirical evidence. We augment this model with Epstein and Zin (1989) preferences (EZ-BKK) and characterize the resulting recursive risk-sharing scheme. The response of international capital flows in the EZ-BKK model is consistent with the data. With Max Croce, Steven Ho, and Philip Howard.

Skewness in Expected Macro Fundamentals and the Predictability of Equity Returns: Evidence and Theory

Review of Financial Studies (2016)

Key Insight: Time-varying skewness in expected macroeconomic fundamentals helps predict equity excess returns and amplifies model-implied equity risk premia.

Why it Matters: The paper links cross-sectional disagreement among professional forecasters to asset prices, showing that higher moments of growth expectations contain economically relevant information about market compensation for risk.

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We show that introducing time-varying skewness in the distribution of expected growth prospects in an otherwise standard endowment economy can up to double the model implied equity Sharpe ratios, and produce a substantial amount of fluctuation in equity risk premia. Looking at the Livingston Survey, we document that the first and third cross-sectional moments of the distribution of GDP growth rates made by professional forecasters can predict equity excess returns, a finding which is consistent with our consumption based asset pricing model. With Eric Ghysels, Jinghan Meng, and Wasin Siwasarit.

International Asset Pricing with Recursive Preferences

The Journal of Finance (2013)

Key Insight: Recursive preferences and correlated long-run growth prospects can turn classic international finance anomalies into equilibrium regularities.

Why it Matters: The paper provides a unified general-equilibrium framework for understanding exchange-rate behavior, consumption risk sharing, and currency risk premia.

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Focusing on the U.S. and U.K., we document that both the Backus and Smith finding, concerning the low correlation between consumption differentials and exchange rates, and the forward-premium anomaly, concerning the tendency of high interest rate currencies to appreciate, have become more severe through time. After accounting for different capital mobility regimes, we show that these anomalies turn into general equilibrium regularities in a two-country and two-good economy with Epstein and Zin preferences, frictionless markets, and correlated long-run growth prospects. With Max Croce.

O’ Sole Mio: An Experimental Analysis of Weather and Risk Attitudes in Financial Decisions

Review of Financial Studies (2013)

Key Insight: Sunshine and favorable weather increase risk-taking in financial decisions, partly through their effect on mood.

Why it Matters: The paper provides experimental evidence on a behavioral channel through which weather can affect financial choices and market behavior.

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Although weather has been shown to affect financial markets and financial decision making, a still open question is the channel through which such influence is exerted. By employing a multiple price list method, this paper provides direct experimental evidence that sunshine and good weather promote risk-taking behavior. This effect is present whether relying on objective measures of meteorological conditions or subjective weather assessments. Finally, employing a psychological test, we find evidence that weather may affect individual risk tolerance through its effect on mood. With Anna Bassi and Paolo Fulghieri.

International Robust Disagreement

The American Economic Review Papers & Proceedings (2012)

Key Insight: In a two-country economy with home bias and fear of model misspecification, disagreement about growth prospects can arise endogenously.

Why it Matters: The paper shows how robust preferences can generate persistent international disagreement, with implications for risk sharing and international asset prices.

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We characterize the equilibrium of a two-country, two-good economy in which agents have opposite bias toward one of the two consumption goods and fear model misspecification. We document that disagreement about endowments’ growth prospects is a natural outcome of this class of economies. With Max Croce.

A Component Model for Dynamic Correlations

Journal of Econometrics (2011)

Key Insight: Dynamic correlations can be modeled as the combination of short-run movements and a persistent long-run component.

Why it Matters: The DCC-MIDAS framework provides an econometrically disciplined way to measure changing dependence across assets while preserving valid correlation matrices.

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The idea of component models for volatility is extended to dynamic correlations. We propose a model of dynamic correlations with a short- and long-run component specification. We call it the class of models DCC-MIDAS as the key ingredients are a combination of the Engle (2002) DCC model, the Engle and Lee (1999) component GARCH model to replace the original DCC dynamics with a component specification and the Engle, Ghysels, and Sohn (2006) GARCH-MIDAS component specification that allows us to extract a long-run correlation component via mixed data sampling. We provide a comprehensive econometric analysis of the new class of models, including conditions for positive semi-definiteness, and provide extensive empirical evidence that supports the model specification. With Robert Engle and Eric Ghysels.

Risks for the Long Run and the Real Exchange Rate

Journal of Political Economy (2011)

Key Insight: Highly correlated long-run growth risks can reconcile the behavior of real exchange rates with international consumption risk sharing.

Why it Matters: The paper offers a recursive-preferences explanation for why price-based and quantity-based measures of international stochastic discount factors appear so different.

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Brandt, Cochrane, and Santa-Clara (2004) point out that the implicit stochastic discount factors computed using prices on the one hand and consumption growth on the other hand have very different implications for their cross country correlation. They leave this as an unresolved puzzle. We explain it by combining Epstein and Zin (1989) preferences with a model of predictable returns and by positing a very correlated long run component. We also assume that the intertemporal elasticity of substitution is larger than one. This setup brings the stochastic discount factors computed using prices and quantities close together, by keeping the volatility of the depreciation rate in the order of 14% and the cross country correlation of consumption growth around 30%. With Max Croce.

The Short- and Long-Run Benefits of Financial Integration

American Economic Review Papers & Proceedings (2010)

Key Insight: Financial integration can generate large welfare gains when agents care about the timing of uncertainty resolution and endowments contain persistent long-run risks.

Why it Matters: The paper revisits the classic view that international diversification yields small gains and shows that recursive preferences can substantially change the welfare assessment.

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Cole and Obstfeld (1991) pointed out that the welfare benefits of international portfolio diversification might be negligible. They obtain this result in the context of a model in which agents have time-additive constant relative risk aversion preferences. We revisit their conclusion by showing that a preference for the timing of the resolution of uncertainty combined with endowments containing a slowly moving trend can result in extremely high welfare gains. With Max Croce.

Robustness and US Monetary Policy Experimentation

Journal of Money, Credit, and Banking (2008)

Key Insight: Concerns about model misspecification can materially alter a policymaker’s incentive to experiment when learning about inflation-unemployment dynamics.

Why it Matters: The paper shows that robustness concerns affect monetary policy differently depending on whether uncertainty concerns the economic submodels or the prior probabilities assigned to them.

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We study how a concern for robustness modifies a policy maker’s incentive to experiment. A policy maker has a prior over two submodels of inflation-unemployment dynamics. One submodel implies an exploitable trade-off, the other does not. Bayes’ law gives the policy maker an incentive to experiment. The policy maker fears that both submodels and prior probability distribution over them are misspecified. We compute decision rules that are robust to misspecifications of the dynamics posited by each submodel as well as the prior distribution over submodels. We compare robust rules to ones that Cogley, Colacito, and Sargent (2007) computed assuming that the models and the prior distribution are correctly specified. We explain why the policy maker’s desires to protect against misspecifications of the submodels, on the one hand, and misspecifications of the prior over them, on the other, have different effects on the decision rule. With Tim W. Cogley, Lars Peter Hansen, and Tom J. Sargent.

Term Structure of Risk, the Role of Known and Unknown Risks and Non-Stationary Distributions

The Known, the Unknown and the Unknowable in Financial Risk Management

Key Insight: Risk varies systematically across horizons, and this term structure can be measured using horizon-specific volatility and VaR forecasts.

Why it Matters: Recognizing the horizon dependence of risk can improve asset allocation decisions by aligning portfolio choices with the investor’s relevant risk horizon.

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In this paper we document the presence of a time structure of risk and we propose how to measure it using alternative models to forecast volatility and the VaR at different horizons. We then quantify the benefits of an investor that is aware of the existence of a term structure of risk in the context of an asset allocation exercise. With Robert Engle.

Benefits from U.S. Monetary Policy Experimentation

Journal of Money, Credit, and Banking (2006)

Key Insight: Bayesian learning about competing inflation-unemployment models can create an incentive for monetary policymakers to experiment.

Why it Matters: The paper shows how model uncertainty and learning can shape policy choices in ways that differ from standard anticipated-utility approximations.

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A policy maker knows two models of inflation-unemployment dynamics. One implies an exploitable trade-off. The other does not. The policy maker’s prior probability over the two models is part of his state vector. Bayes law converts the prior into a posterior at each date and gives the policy maker an incentive to experiment. For a model calibrated to U.S. data through the early 1960s, we isolate the component of government policy that is due to experimentation by comparing the outcomes from two Bellman equations, the first of which embodies an “experiment and learn” setup, the second of which embodies a “don’t experiment, do learn” view. We interpret the second as an example of an “anticipated utility” model and study how well its outcomes approximate those from the “experiment and learn” Bellman equation. With Tim Cogley and Tom Sargent.

Testing and Valuing Dynamic Correlation for Asset Allocation

Journal of Business and Economic Statistics (2006)

Key Insight: Correctly modeling time-varying correlations can materially improve portfolio risk management and asset allocation performance.

Why it Matters: The paper provides an economically interpretable way to evaluate covariance models by measuring their value in portfolio decisions rather than only by statistical fit.

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We evaluate alternative models of variances and correlations with an economic loss function. We construct portfolios to minimize predicted variance subject to a required return. It is shown that the realized volatility is smallest for the correctly specified covariance matrix for any vector of expected returns. A test of relative performance of two covariance matrices is based on Diebold and Mariano (1995). The method is applied to stocks and bonds and then to highly correlated assets. On average dynamically correct correlations are worth around 60 basis points in annualized terms but on some days they may be worth hundreds. With Robert F. Engle.