This study summarises the basic facts related to the investment strategy known as carry trade. Carry trade is a leveraged investment transaction limited to the foreign exchange market. Foreign investors can only realise extra return if they also assume the risk of exchange rate fluctuations. Carry trade produces high returns for years, but in turbulent periods the accumulated profits of several years can be lost within a matter of weeks. High yielding currencies go through a long period of appreciation, interrupted by sudden strong weakening episodes. Theoretical economists explain stylised facts with the volatility of the risk premium or the liquidity constraints of investors, or with exchange rate bubbles. Foreign investors financing the Hungarian economy did not increase, on aggregate, their exposure to Hungarian forints during the last decade. Consequently, the underlying cause of Hungary’s external indebtedness is most probably not the carry trade activity of foreigners. However, the role of carry trade in the exchange rate dynamics of Hungarian forint may have increased in the last couple of years.
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