"Currency excess returns are highly predictable, more than stock returns, and about as much as bond returns. In addition, these predicted excess returns are strongly counter-cyclical. The average excess returns on low interest rate currencies are 4.8 percent per annum smaller than those on high interest rate currencies after accounting for transaction costs. We show that a single return-based factor, the return on the highest minus the return on the lowest interest rate currency portfolios, explains the cross-sectional variation in average currency excess returns from low to high interest rate currencies. This evidence suggests currency risk premia are large and time-varying. In a simple affine pricing model, we show that the high-minus-low currency return measures the component of the stochastic discount factor innovations that is common across countries. To match the carry trade returns in the data, low interest rate currencies need to load more on this common innovation when the market price of global risk is high"--National Bureau of Economic Research web site.