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Currency carry trade regimes: Beyond the Fama regression

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  • Clarida, Richard
  • Davis, Josh
  • Pedersen, Niels

Abstract

We show that carry trade strategies resemble FX option strategies that sell out of the money puts on high interest rate currencies. Both strategies collect premiums to generate persistent excess returns that unwind sharply when volatility increases. We also show that the widely documented negative slope coefficient in regressions of exchange rate depreciation on forward currency premiums is an artifact of the volatility regime. In high volatility regimes, the so-called Fama regression produces a positive coefficient greater than unity. We finally document the existence of an intuitive co-movement between currency risk premiums and yield curve risk factors.

Suggested Citation

  • Clarida, Richard & Davis, Josh & Pedersen, Niels, 2009. "Currency carry trade regimes: Beyond the Fama regression," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1375-1389, December.
  • Handle: RePEc:eee:jimfin:v:28:y:2009:i:8:p:1375-1389
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    More about this item

    Keywords

    Currency carry trade Risk premium Fama Yield curve risk premia;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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