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

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  • Wagner, Christian

Abstract

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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  • Wagner, Christian, 2012. "Risk-premia, carry-trade dynamics, and economic value of currency speculation," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1195-1219.
  • Handle: RePEc:eee:jimfin:v:31:y:2012:i:5:p:1195-1219
    DOI: 10.1016/j.jimonfin.2012.01.013
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    Cited by:

    1. Egbers, Tom & Swinkels, Laurens, 2015. "Can implied volatility predict returns on the currency carry trade?," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 14-26.
    2. repec:spr:empeco:v:54:y:2018:i:4:d:10.1007_s00181-017-1268-8 is not listed on IDEAS
    3. Norman C. Miller, 2014. "Exchange Rate Economics," Books, Edward Elgar Publishing, number 14981.
    4. Potì, Valerio & Siddique, Akhtar, 2013. "What drives currency predictability?," Journal of International Money and Finance, Elsevier, vol. 36(C), pages 86-106.

    More about this item

    Keywords

    Exchange rates; Uncovered interest parity; Risk-premia; Carry-trade; Economic value;

    JEL classification:

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

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