The Revenge of Purchasing Power Parity on Carry Trades during Crises
AbstractEmpirical evidence shows that fundamental models have produced disappointing results over the past 20 years while carry trade strategies have performed superbly. But the real picture is much more complex. In fact, the track records of both strategies have varied considerably. This article shows that they have actually alternated between periods of profitability and underperformance. It also shows that when carry trade strategies perform well, fundamental strategies do poorly, and vice versa. Crises appear to play a significant role in the alternation of investment styles on currency markets. In contrast to carry trades, fundamental strategies perform remarkably well in crises. A portfolio that rotates between these two types of strategies, based on a risk aversion indicator such as implied equity volatility, would substantially outperform a pure carry trade strategy and would be robust to crises.
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Bibliographic InfoPaper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 09-013.RS.
Length: 27 p.
Date of creation: 2009
Date of revision:
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More information through EDIRC
carry trades; exchange rates; financial crisis; risk aversion; investment strategy; purchasing power parity; fundamentals model.;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-03-14 (All new papers)
- NEP-CBA-2009-03-14 (Central Banking)
- NEP-IFN-2009-03-14 (International Finance)
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