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Do Peso Problems Explain the Returns to the Carry Trade?

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  • A. Craig Burnside
  • Martin Eichenbaum
  • Isaac Kleshchelski
  • Sergio T. Rebelo

Abstract

We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates

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Bibliographic Info

Paper provided by Duke University, Department of Economics in its series Working Papers with number 10-44.

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Length: 82
Date of creation: 2010
Date of revision:
Handle: RePEc:duk:dukeec:10-44

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Postal: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
Phone: (919) 660-1800
Fax: (919) 684-8974
Web page: http://econ.duke.edu/

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  1. Taylor, Mark P, 1987. "Covered Interest Parity: A High-Frequency, High-Quality Data Study," Economica, London School of Economics and Political Science, vol. 54(216), pages 429-38, November.
  2. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," NBER Working Papers 11034, National Bureau of Economic Research, Inc.
  3. A. Craig Burnside, 2010. "Empirical Asset Pricing and Statistical Power in the Presence of Weak Risk Factors," Working Papers 10-45, Duke University, Department of Economics.
  4. Clinton, Kevin, 1988. "Transactions Costs and Covered Interest Arbitrage: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 358-70, April.
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