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Carry Trade: The Gains of Diversification

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Author Info

  • Craig Burnside
  • Martin Eichenbaum
  • Sergio Rebelo

Abstract

Market participants routinely take advantage of the failure of uncovered interest rate parity to speculate in currency markets. Perhaps the most widely used currency speculation strategy is the carry trade. In this article we take the perspective of an individual currency trader and document the gains to diversifying the carry trade across different currencies. We show that these gains are large. Diversification boosts the typical Sharpe ratio by over 50%. (c) 2008 by the European Economic Association.

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Bibliographic Info

Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 6 (2008)
Issue (Month): 2-3 (04-05)
Pages: 581-588

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Handle: RePEc:tpr:jeurec:v:6:y:2008:i:2-3:p:581-588

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Web page: http://www.mitpressjournals.org/jeea

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Cited by:
  1. Hanno Lustig & Adrien Verdelhan, 2011. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk: Reply," American Economic Review, American Economic Association, vol. 101(7), pages 3477-3500, December.
  2. Menkhoff, Lukas & Sarno, Lucio & Schmeling, Maik & Schrimpf, Andreas, 2012. "Currency momentum strategies," Journal of Financial Economics, Elsevier, vol. 106(3), pages 660-684.
  3. Òscar Jordà & Alan M. Taylor, 2009. "The Carry Trade and Fundamentals: Nothing to Fear But FEER Itself," NBER Working Papers 15518, National Bureau of Economic Research, Inc.
  4. Wagner, Christian, 2009. "Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation," MPRA Paper 21125, University Library of Munich, Germany.
  5. John, Pippenger, 2011. "The solution to the forward-bias puzzle: Reply," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 629-636, October.
  6. Charles Engel, 2013. "Exchange Rates and Interest Parity," NBER Working Papers 19336, National Bureau of Economic Research, Inc.
  7. Shakill Hassan & Sean Smith, 2011. "The Rand as a Carry Trade Target: Risk, Returns and Policy Implications," Working Papers 235, Economic Research Southern Africa.
  8. Pippenger, John, 2013. "The Failure Of Uncovered Interest Parity, Forward Bias And Related Puzzles," University of California at Santa Barbara, Economics Working Paper Series qt50n5p8bv, Department of Economics, UC Santa Barbara.

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