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Carry Trades and Global FX Volatility

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Author Info
Menkhoff, Lukas
Sarno, Lucio
Schmeling, Maik
Schrimpf, Andreas

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Abstract

We investigate the relation between global FX volatility and the excess returns to carry trade portfolios. We find a significantly negative return co-movement of high interest rate currencies with global volatility, whereas low interest rate currencies provide a hedge against volatility shocks. Our main global FX volatility proxy accounts for more than 90% of the return spread in five carry trade portfolios. Further analyses show that: (i) liquidity risk also matters for excess returns, but to a lesser degree; and that (ii) excess returns are more strongly related to unexpected components of volatility than to expected components. Our results are robust to different proxies for volatility risk, and extend to other cross-sections such as individual currency returns and (some) momentum portfolios.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 14728.

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Date of creation: 07 Apr 2009
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Handle: RePEc:pra:mprapa:14728

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Related research
Keywords: Carry Trade; Volatility; Liquidity; Forward Premium Puzzle;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
F31 - International Economics - - International Finance - - - Foreign Exchange

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This page was last updated on 2009-11-22.

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