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The Carry Trade: Risks and Drawdowns

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  • Daniel, Kent
  • Hodrick, Robert J.
  • Lu, Zhongjin

Abstract

We find important differences in dollar-based and dollar-neutral G10 carry trades. Dollar-neutral trades have positive average returns, are highly negatively skewed, are correlated with risk factors, and exhibit considerable downside risk. In contrast, a diversified dollar-carry portfolio has a higher average excess return, a higher Sharpe ratio, minimal skewness, is unconditionally uncorrelated with standard risk-factors, and exhibits no downside risk. Distributions of drawdowns and maximum losses from daily data indicate a role for timevarying autocorrelation in determining negative skewness at longer horizons.

Suggested Citation

  • Daniel, Kent & Hodrick, Robert J. & Lu, Zhongjin, 2017. "The Carry Trade: Risks and Drawdowns," Critical Finance Review, now publishers, vol. 6(2), pages 211-262, September.
  • Handle: RePEc:now:jnlcfr:104.00000051
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    File URL: http://dx.doi.org/10.1561/104.00000051
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    Citations

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    Cited by:

    1. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2015. "Carry and Trend Following Returns in the Foreign Exchange Market," Discussion Papers 15/07, Department of Economics, University of York.
    2. Michael Melvin & Duncan Shand, 2016. "When Carry Goes Bad: The Magnitude, Causes, and Duration of Currency Carry Unwinds," CESifo Working Paper Series 6210, CESifo Group Munich.
    3. repec:eee:empfin:v:42:y:2017:i:c:p:199-211 is not listed on IDEAS

    More about this item

    Keywords

    Currency carry trade; Currency risk factors; Market efficiency;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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