I’ve wondered about this for years, here is a neat but to me unconvincing result:
Aggregate consumption growth risk explains why low interest rate currencies
do not appreciate as much as the interest rate differential and why high interest rate currencies do not depreciate as much as the interest rate differential. Domestic investors earn negative excess returns on low interest rate currency portfolios and positive excess returns on high interest rate currency portfolios. Because high interest rate currencies depreciate on average when domestic consumption growth is low and low interest rate currencies appreciate under the same conditions, low interest rate currencies provide domestic investors with a hedge against domestic aggregate consumption growth risk.
That is from The American Economic Review, March 2007. Here is an earlier version of the paper.
If you are investing lots of money in foreign currencies in the first place, how much consumption risk do you really face these days? (And does this mean that philosophical Stoics, who can make do with whatever, should load up on the Kiwi dollar?) I tend to think there are now enough marginal investors who are in any case set for life in terms of consumption risk or rather the lack thereof.
Simple home bias, and the fear of looking like a fool, may be better explanations for the persistence of high nominal interest rate currencies which do not on average depreciate very much. Yes it sounds a little lame to postulate those loose millions, but a) it’s only in expected value terms, and b) it is consistent with the fact that investors don’t optimally diversify across borders either.