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Currency Carry Trades

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  • Travis J. Berge
  • Òscar Jordà
  • Alan M. Taylor

Abstract

A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16491.

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Date of creation: Oct 2010
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Publication status: published as Travis Berge & �scar Jord� & Alan M. Taylor, 2011. "Currency Carry Trades," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 7(1), pages 357 - 388.
Handle: RePEc:nbr:nberwo:16491

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  1. Kilian, Lutz & Taylor, Mark P, 2001. "Why is it so Difficult to Beat the Random Walk Forecast of Exchange Rates?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3024, C.E.P.R. Discussion Papers.
  2. Eric O'N. Fisher, 2000. "The Forward Premium in a Model with Heterogeneous Prior Beliefs," Working Papers, Ohio State University, Department of Economics 01-05, Ohio State University, Department of Economics.
  3. Michael Melvin & Mark P. Taylor, 2009. "The Crisis in the Foreign Exchange Market," CESifo Working Paper Series 2707, CESifo Group Munich.
  4. Cheung, Yin-Wong & Chinn, Menzie D. & Pascual, Antonio Garcia, 2005. "Empirical exchange rate models of the nineties: Are any fit to survive?," Journal of International Money and Finance, Elsevier, Elsevier, vol. 24(7), pages 1150-1175, November.
  5. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 13(3), pages 253-63, July.
  6. Giacomini, Raffaella & White, Halbert, 2003. "Tests of Conditional Predictive Ability," University of California at San Diego, Economics Working Paper Series, Department of Economics, UC San Diego qt5jk0j5jh, Department of Economics, UC San Diego.
  7. Yu-chin Chen & Kwok Ping Tsang, 2009. "What Does the Yield Curve Tell Us About Exchange Rate Predictability?," Working Papers e07-15, Virginia Polytechnic Institute and State University, Department of Economics.
  8. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347 National Bureau of Economic Research, Inc.
  9. Luboš Pástor & Robert F. Stambaugh, . "Liquidity Risk and Expected Stock Returns," CRSP working papers, Center for Research in Security Prices, Graduate School of Business, University of Chicago 531, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  10. Geert Bekaert & Robert J. Hodrick, 1991. "On Biases in the Measurement of Foreign Exchange Risk Premiums," NBER Working Papers 3861, National Bureau of Economic Research, Inc.
  11. Cosmin Ilut, 2009. "Ambiguity Aversion: Implications For The Uncovered Interest Rate Parity Puzzle," 2009 Meeting Papers, Society for Economic Dynamics 328, Society for Economic Dynamics.
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Cited by:
  1. Òscar Jordà & Alan M. Taylor, 2011. "Performance Evaluation of Zero Net-Investment Strategies," NBER Working Papers 17150, National Bureau of Economic Research, Inc.
  2. Travis J. Berge, 2011. "Forecasting disconnected exchange rates," Research Working Paper, Federal Reserve Bank of Kansas City RWP 11-12, Federal Reserve Bank of Kansas City.
  3. Travis Berge & Òscar Jordà, 2013. "A chronology of turning points in economic activity: Spain, 1850–2011," SERIEs, Spanish Economic Association, Spanish Economic Association, vol. 4(1), pages 1-34, March.

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