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The carry trade and fundamentals: Nothing to fear but FEER itself

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  • Jordà, Òscar
  • Taylor, Alan M.

Abstract

Risky arbitraging based on interest rate differentials between two countries is typically referred to as a carry trade. Up until the recent global financial crisis, these trades generated years of persistent positive returns, which were hard to reconcile with standard pricing kernels. In 2008 these trades blew up, which seemed to weaken the case for a puzzle relating to predictable currency returns. But the rise and fall of this puzzle in the academic literature has only been concerned with naïve carry trades based on yield signals alone. We show, however, that some simple and more realistic fundamentals-augmented trading strategies would have generated strong and sustained positive profits that endured through the turmoil.

Suggested Citation

  • Jordà, Òscar & Taylor, Alan M., 2012. "The carry trade and fundamentals: Nothing to fear but FEER itself," Journal of International Economics, Elsevier, vol. 88(1), pages 74-90.
  • Handle: RePEc:eee:inecon:v:88:y:2012:i:1:p:74-90
    DOI: 10.1016/j.jinteco.2012.03.001
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    More about this item

    Keywords

    Uncovered interest parity; Efficient markets; Exchange rates; Receiver operating characteristic curve; Correct classification frontier;
    All these keywords.

    JEL classification:

    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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