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Risk-premia, carry-trade dynamics, and economic value of currency speculation

  • Wagner, Christian

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, however, the economic value generated by bilateral carry-trades is limited.

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File URL: http://www.sciencedirect.com/science/article/pii/S0261560612000216
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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 31 (2012)
Issue (Month): 5 ()
Pages: 1195-1219

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Handle: RePEc:eee:jimfin:v:31:y:2012:i:5:p:1195-1219
DOI: 10.1016/j.jimonfin.2012.01.013
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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