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Risk-premia, carry-trade dynamics, and economic value of currency speculation

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  • Wagner, Christian

Abstract

In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited ‘forward bias puzzle’ originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia, however, the economic value generated by bilateral carry-trades is limited.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 31 (2012)
Issue (Month): 5 ()
Pages: 1195-1219

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Handle: RePEc:eee:jimfin:v:31:y:2012:i:5:p:1195-1219

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Web page: http://www.elsevier.com/locate/inca/30443

Related research

Keywords: Exchange rates; Uncovered interest parity; Risk-premia; Carry-trade; Economic value;

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References

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Cited by:
  1. Potì, Valerio & Siddique, Akhtar, 2013. "What drives currency predictability?," Journal of International Money and Finance, Elsevier, vol. 36(C), pages 86-106.

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