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The carry trade in industrialized and emerging markets

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  • Craig Burnside

Abstract

I revisit the evidence on the profits associated with currency carry trades, explore its relationship to the uncovered interest parity (UIP) puzzle and the behavior of risk premia. I confirm earlier findings that carry trades are profitable, and that UIP fails for a group of industrialized-country currencies. Emerging market carry trades are also profitable, despite there being less "statistical" evidence against UIP. Because most emerging market currencies have persistently high interest rates, time variation in the risk premia of these currencies plays a smaller role in the average profits to emerging market carry trades. I find that those risk factors that seem able to summarize or explain the returns to carry trades in industrialized economies do not explain the returns to investing in emerging market currencies. Additionally, I find that BIS bank capital is relatively insensitive to the interest differentials that make carry trades attractive to investors.

Suggested Citation

  • Craig Burnside, 2014. "The carry trade in industrialized and emerging markets," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 17(2), pages 48-78, August.
    • Handle: RePEc:chb:bcchec:v:17:y:2014:i:2:p:48-78
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    References listed on IDEAS

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    1. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2011. "Do Peso Problems Explain the Returns to the Carry Trade?," The Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 853-891.
    2. Tarek A Hassan & Rui C Mano, 2019. "Forward and Spot Exchange Rates in a Multi-Currency World," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(1), pages 397-450.
    3. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, vol. 97(1), pages 89-117, March.
    4. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    5. Bekaert, Geert & Hodrick, Robert J, 1992. "Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
    6. Backus, David K & Gregory, Allan W & Telmer, Chris I, 1993. "Accounting for Forward Rates in Markets for Foreign Currency," Journal of Finance, American Finance Association, vol. 48(5), pages 1887-1908, December.
    7. Bilson, John F O, 1981. "The "Speculative Efficiency" Hypothesis," The Journal of Business, University of Chicago Press, vol. 54(3), pages 435-451, July.
    8. Shin, Hyun Song & Plantin, Guillaume, 2011. "Carry Trades, Monetary Policy and Speculative Dynamics," CEPR Discussion Papers 8224, C.E.P.R. Discussion Papers.
    9. Villanueva, O. Miguel, 2007. "Forecasting Currency Excess Returns: Can the Forward Bias Be Exploited?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(4), pages 963-990, December.
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    Cited by:

    1. repec:beo:journl:v:62:y:2018:i:216:p:35-62 is not listed on IDEAS
    2. Claudio Raddatz & Diego Saravia & Jaume Ventura, 2015. "Global Liquidity, Spillovers to Emerging Markets and Policy Responses: An Overview," Central Banking, Analysis, and Economic Policies Book Series, in: Claudio Raddatz & Diego Saravia & Jaume Ventura (ed.),Global Liquidity, Spillovers to Emerging Markets and Policy Responses, edition 1, volume 20, chapter 1, pages 001-011, Central Bank of Chile.
    3. Ragna Alstadheim & Christine Blandhol, 2018. "The global financial cycle, bank capital flows and monetary policy. Evidence from Norway," Working Paper 2018/2, Norges Bank.
    4. Zorica Mladenović & Jelena Rašković, 2018. "Econometric Testing Of Uncovered Interest Rate Parity In Serbia," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 63(216), pages 35-62, January –.
    5. Geyikçi, Utku Bora & Özyıldırım, Süheyla, 2021. "To hedge or not to hedge: Carry trade dynamics in the emerging economies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 73(C).
    6. Craig Burnside & Mario Cerrato & Zhekai Zhang, "undated". "Foreign exchange order flow as a risk factor," Working Papers 2023-03, Business School - Economics, University of Glasgow.
    7. Vasilyev, Dmitry (Васильев, Дмитрий) & Busygin, Vladimir (Бусыгин, Владимир) & Busygin, Sergei (Бусыгин, Сергей), 2016. "Testing and Interpreting Uncovered Interest Parity in Russia [Проверка И Интерпретация Выполнения Процентного Паритета В России]," Ekonomicheskaya Politika / Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 4, pages 35-55, August.
    8. Wenliang Guo, 2020. "Currency Regimes, Volatility Risks, and Carry Trades: The Option Value of Government Currency Intervention in Emerging Markets," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 10(3), pages 1-4.
    9. Auer, Benjamin R. & Hoffmann, Andreas, 2016. "Do carry trade returns show signs of long memory?," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 201-208.

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