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The carry trade and fundamentals: Nothing to fear but FEER itself

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  • Jordà, Òscar
  • Taylor, Alan M.

Abstract

Risky arbitraging based on interest rate differentials between two countries is typically referred to as a carry trade. Up until the recent global financial crisis, these trades generated years of persistent positive returns, which were hard to reconcile with standard pricing kernels. In 2008 these trades blew up, which seemed to weaken the case for a puzzle relating to predictable currency returns. But the rise and fall of this puzzle in the academic literature has only been concerned with naïve carry trades based on yield signals alone. We show, however, that some simple and more realistic fundamentals-augmented trading strategies would have generated strong and sustained positive profits that endured through the turmoil.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 88 (2012)
Issue (Month): 1 ()
Pages: 74-90

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Handle: RePEc:eee:inecon:v:88:y:2012:i:1:p:74-90

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Web page: http://www.elsevier.com/locate/inca/505552

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Keywords: Uncovered interest parity; Efficient markets; Exchange rates; Receiver operating characteristic curve; Correct classification frontier;

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References

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Citations

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Cited by:
  1. Charles Engel, 2011. "The Real Exchange Rate, Real Interest Rates, and the Risk Premium," NBER Working Papers 17116, National Bureau of Economic Research, Inc.
  2. Neely, Christopher J. & Weller, Paul A., 2013. "Lessons from the evolution of foreign exchange trading strategies," Journal of Banking & Finance, Elsevier, vol. 37(10), pages 3783-3798.
  3. Malliaris, A.G. & Malliaris, Mary, 2011. "Are foreign currency markets interdependent? evidence from data mining technologies," MPRA Paper 35261, University Library of Munich, Germany.
  4. Habib, Maurizio Michael & Stracca, Livio, 2011. "Getting beyond carry trade: what makes a safe haven currency?," Working Paper Series 1288, European Central Bank.
  5. Mathias Hoffmann & Rahel Suter, 2013. "Systematic consumption risk in currency returns," ECON - Working Papers 124, Department of Economics - University of Zurich.
  6. Travis J. Berge & Òscar Jordà, 2011. "Evaluating the Classification of Economic Activity into Recessions and Expansions," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 246-77, April.
  7. Charles Engel, 2013. "Exchange Rates and Interest Parity," NBER Working Papers 19336, National Bureau of Economic Research, Inc.
  8. Ian Martin, 2011. "The Forward Premium Puzzle in a Two-Country World," NBER Working Papers 17564, National Bureau of Economic Research, Inc.
  9. Cho, Dooyeon & Doblas-Madrid, Antonio, 2014. "Trade intensity and purchasing power parity," Journal of International Economics, Elsevier, vol. 93(1), pages 194-209.
  10. Snaith, Stuart & Coakley, Jerry & Kellard, Neil, 2013. "Does the forward premium puzzle disappear over the horizon?," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3681-3693.
  11. Reinout De Bock & Irineu E. Carvalho Filho, 2013. "The Behavior of Currencies during Risk-off Episodes," IMF Working Papers 13/8, International Monetary Fund.
  12. Ding, Liang & Ma, Jun, 2013. "Portfolio reallocation and exchange rate dynamics," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 3100-3124.
  13. Huang, Huichou & MacDonald, Ronald & Zhao, Yang, 2012. "Global Currency Misalignments, Crash Sensitivity, and Downside Insurance Costs," MPRA Paper 53745, University Library of Munich, Germany, revised 18 Nov 2013.
  14. Dick, Christian D. & MacDonald, Ronald & Menkhoff, Lukas, 2011. "Individual exchange rate forecasts and expected fundamentals," ZEW Discussion Papers 11-062, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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