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Speculative capital and currency carry trades

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  • Jylhä, Petri
  • Suominen, Matti

Abstract

In this paper, we study a two-country general equilibrium model with partially segmented financial markets, where hedge funds emerge endogenously. Empirically, we show that the hedge fund investment strategy predicted by our model, which we call the "risk-adjusted carry trade" strategy, explains more than 16% of the overall hedge fund index returns and more than 33% of the fixed income arbitrage sub-index returns. The flow of new money to hedge funds affects market interest rates, exchange rates, and both the hedge funds' contemporaneous and expected future returns as predicted by the model.

Suggested Citation

  • Jylhä, Petri & Suominen, Matti, 2011. "Speculative capital and currency carry trades," Journal of Financial Economics, Elsevier, vol. 99(1), pages 60-75, January.
    • Handle: RePEc:eee:jfinec:v:99:y:2011:i:1:p:60-75
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    3. Pedro Barroso & Jurij-Andrei Reichenecker & Marco J. Menichetti, 2022. "Hedging with an Edge: Parametric Currency Overlay," Management Science, INFORMS, vol. 68(1), pages 669-689, January.
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    6. Fong, Wai Mun, 2013. "Footprints in the market: Hedge funds and the carry trade," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 41-59.
    7. Ali Shehadeh & Peter Erdos & Youwei Li & Michael Moore, 2016. "US Dollar Carry Trades in the Era of "Cheap Money"," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 66(5), pages 374-404, October.
    8. Faria, Gonçalo & Kosowski, Robert & Wang, Tianyu, 2022. "The Correlation Risk Premium: International Evidence," Journal of Banking & Finance, Elsevier, vol. 136(C).
    9. Francis Breedon & Dagfinn Rime & Paolo Vitale, 2016. "Carry Trades, Order Flow, and the Forward Bias Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(6), pages 1113-1134, September.
    10. Hau, Harald, 2014. "The exchange rate effect of multi-currency risk arbitrage," Journal of International Money and Finance, Elsevier, vol. 47(C), pages 304-331.
    11. Byrne, Joseph P. & Ibrahim, Boulis Maher & Sakemoto, Ryuta, 2019. "Carry trades and commodity risk factors," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 121-129.
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    14. Stephen A. Gorman & Frank J. Fabozzi, 2021. "The ABC’s of the alternative risk premium: academic roots," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 405-436, October.
    15. Georgios, Katechos, 2011. "On the relationship between exchange rates and equity returns: A new approach," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 550-559, October.
    16. Chen, Chih-Nan & Lin, Chien-Hsiu, 2020. "The sources of pricing factors underlying the cross-section of currency returns," The Quarterly Review of Economics and Finance, Elsevier, vol. 77(C), pages 250-265.
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    18. Francis Breedon & Dagfinn Rime & Paolo Vitale, 2016. "Carry Trades, Order Flow, and the Forward Bias Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(6), pages 1113-1134, September.
    19. Robin Greenwood & Samuel G. Hanson & Jeremy C. Stein & Adi Sunderam, 2020. "A Quantity-Driven Theory of Term Premia and Exchange Rates," NBER Working Papers 27615, National Bureau of Economic Research, Inc.
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    21. Joni Kokkonen & Matti Suominen, 2015. "Hedge Funds and Stock Market Efficiency," Management Science, INFORMS, vol. 61(12), pages 2890-2904, December.
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