The carry trade strategy involves selling forward currencies that are at a forward premium and buying forward currencies that are at a forward discount. We compare the payoffs to the carry trade applied to two different portfolios. The first portfolio consists exclusively of developed country currencies. The second portfolio includes the currencies of both developed countries and emerging markets. Our main empirical findings are as follows. First, including emerging market currencies in our portfolio substantially increases the Sharpe ratio associated with the carry trade. Second, bid-ask spreads are two to four times larger in emerging markets than in developed countries. Third and most dramatically, the payoffs to the carry trade for both portfolios are uncorrelated with returns to the U.S. stock market.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
12916.
Length: Date of creation: Feb 2007 Date of revision: Handle: RePEc:nbr:nberwo:12916
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Find related papers by JEL classification: F3 - International Economics - - International Finance F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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