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The Returns to Currency Speculation

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  • Craig Burnside
  • Martin Eichenbaum
  • Isaac Kleshchelski
  • Sergio Rebelo

Abstract

Currencies that are at a forward premium tend to depreciate. This 'forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. In practice bid-ask spreads are an increasing function of order size. In addition, there is price pressure, i.e. exchange rates are an increasing function of net order flow. Together these frictions greatly reduce the profitability of currency speculation strategies. In fact, the marginal Sharpe ratio associated with currency speculation can be zero even though the average Sharpe ratio is positive.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12489.

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Date of creation: Aug 2006
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Handle: RePEc:nbr:nberwo:12489

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  24. Alex Maynard, 2003. "Testing for Forward-Rate Unbiasedness: On Regression in Levels and in Returns," The Review of Economics and Statistics, MIT Press, vol. 85(2), pages 313-327, May.
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