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Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation

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  • Wagner, Christian

Abstract

In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited `forward bias puzzle' originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia and generates economic value when applied in multi-currency portfolios.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 21125.

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Date of creation: Aug 2009
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Handle: RePEc:pra:mprapa:21125

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Keywords: Exchange rates; Uncovered interest parity; Risk-premia; Carry-trade; Economic value;

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