Advanced Search
MyIDEAS: Login to save this paper or follow this series

Carry Trades and Global FX Volatility

Contents:

Author Info

  • Menkhoff, Lukas
  • Sarno, Lucio
  • Schmeling, Maik
  • Schrimpf, Andreas

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.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://mpra.ub.uni-muenchen.de/14728/
File Function: original version
Download Restriction: no

Bibliographic Info

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

as in new window
Length:
Date of creation: 07 Apr 2009
Date of revision:
Handle: RePEc:pra:mprapa:14728

Contact details of provider:
Postal: Schackstr. 4, D-80539 Munich, Germany
Phone: +49-(0)89-2180-2219
Fax: +49-(0)89-2180-3900
Web page: http://mpra.ub.uni-muenchen.de
More information through EDIRC

Related research

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

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Motohiro Yogo, 2006. "A Consumption-Based Explanation of Expected Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 61(2), pages 539-580, 04.
  2. Acharya, Viral V & Pedersen, Lasse Heje, 2004. "Asset Pricing with Liquidity Risk," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4718, C.E.P.R. Discussion Papers.
  3. Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2006. "Arbitrage in the Foreign Exchange Market: Turning on the Microscope," SIFR Research Report Series, Institute for Financial Research 42, Institute for Financial Research.
  4. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report, Federal Reserve Bank of Minneapolis 208, Federal Reserve Bank of Minneapolis.
  5. Jonathan A. Parker & Christian Julliard, 2004. "Consumption Risk and the Cross-Section of Expected Returns," Working Papers 138, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
  6. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing specification errors in stochastic discount factor models," Staff Report, Federal Reserve Bank of Minneapolis 167, Federal Reserve Bank of Minneapolis.
  7. Tobias Adrian & Joshua Rosenberg, 2008. "Stock Returns and Volatility: Pricing the Short-Run and Long-Run Components of Market Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 63(6), pages 2997-3030, December.
  8. Engel, Charles M., 1984. "Testing for the absence of expected real profits from forward market speculation," Journal of International Economics, Elsevier, Elsevier, vol. 17(3-4), pages 299-308, November.
  9. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
  10. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, American Economic Association, vol. 83(3), pages 487-512, June.
  11. Bekaert, Geert & Hodrick, Robert J, 1992. " Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 47(2), pages 467-509, June.
  12. Adrien Verdelhan, 2006. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Computing in Economics and Finance 2006, Society for Computational Economics 217, Society for Computational Economics.
  13. A. Craig Burnside & Martin S. Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2008. "Do Peso Problems Explain the Returns to the Carry Trade?," NBER Working Papers 14054, National Bureau of Economic Research, Inc.
  14. Tobias J. Moskowitz & Mark Grinblatt, 1999. "Do Industries Explain Momentum?," Journal of Finance, American Finance Association, American Finance Association, vol. 54(4), pages 1249-1290, 08.
  15. Lubos Pastor & Robert F. Stambaugh, 2001. "Liquidity Risk and Expected Stock Returns," NBER Working Papers 8462, National Bureau of Economic Research, Inc.
  16. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," NBER Working Papers 12489, National Bureau of Economic Research, Inc.
  17. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2009. "Understanding the Forward Premium Puzzle: A Microstructure Approach," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(2), pages 127-54, July.
  18. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 14(3), pages 319-338, November.
  19. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
  20. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, American Finance Association, vol. 48(1), pages 65-91, March.
  21. Hanno Lustig & Nikolai Roussanov & Adrien Verdelhan, 0. "Common Risk Factors in Currency Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 24(11), pages 3731-3777.
  22. Bekaert, Geert, 1994. "Exchange rate volatility and deviations from unbiasedness in a cash-in-advance model," Journal of International Economics, Elsevier, Elsevier, vol. 36(1-2), pages 29-52, February.
  23. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
  24. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2004. "The Cross-Section of Volatility and Expected Returns," NBER Working Papers 10852, National Bureau of Economic Research, Inc.
  25. Harvey, Campbell R. & Siddique, Akhtar, 1999. "Autoregressive Conditional Skewness," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 34(04), pages 465-487, December.
  26. Bekaert, Geert, 1995. "The Time Variation of Expected Returns and Volatility in Foreign-Exchange Markets," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 13(4), pages 397-408, October.
  27. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  28. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(5), pages 829-53, October.
  29. Andersen T. G & Bollerslev T. & Diebold F. X & Labys P., 2001. "The Distribution of Realized Exchange Rate Volatility," Journal of the American Statistical Association, American Statistical Association, American Statistical Association, vol. 96, pages 42-55, March.
  30. Evans, Martin D. D. & Lyons, Richard K., 2002. "Time-varying liquidity in foreign exchange," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(5), pages 1025-1051, July.
  31. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, Econometric Society, vol. 50(4), pages 1029-54, July.
  32. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, Econometric Society, vol. 41(5), pages 867-87, September.
  33. Itamar Drechsler & Amir Yaron, 2008. "What's Vol Got to Do With It," 2008 Meeting Papers 282, Society for Economic Dynamics.
  34. Craig Burnside, 2007. "The Forward Premium is Still a Puzzle," NBER Working Papers 13129, National Bureau of Economic Research, Inc.
  35. Narasimhan Jegadeesh, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, American Finance Association, vol. 56(2), pages 699-720, 04.
  36. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Carol Osler, 2012. "Market Microstructure and the Profitability of Currency Trading," Working Papers, Brandeis University, Department of Economics and International Businesss School 48, Brandeis University, Department of Economics and International Businesss School.
  2. Baillie, Richard T. & Chang, Sanders S., 2011. "Carry trades, momentum trading and the forward premium anomaly," Journal of Financial Markets, Elsevier, Elsevier, vol. 14(3), pages 441-464, August.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:14728. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.