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Currency Carry Trades

  • Travis Berge
  • �scar Jord�
  • Alan M. Taylor

A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.

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File URL: http://www.jstor.org/stable/pdfplus/10.1086/658309
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File URL: http://www.jstor.org/stable/full/10.1086/658309
Download Restriction: Access to the online full text or PDF requires a subscription.

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Article provided by University of Chicago Press in its journal NBER International Seminar on Macroeconomics.

Volume (Year): 7 (2011)
Issue (Month): 1 ()
Pages: 357 - 388

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Handle: RePEc:ucp:intsma:doi:10.1086/658309
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  1. Pástor, Luboš & Stambaugh, Robert F., 2002. "Liquidity Risk and Expected Stock Returns," CEPR Discussion Papers 3494, C.E.P.R. Discussion Papers.
  2. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  3. Raffaella Giacomini & Halbert White, 2003. "Tests of Conditional Predictive Ability," Econometrics 0308001, EconWPA.
  4. Cheung, Yin-Wong & Chinn, Menzie & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Department of Economics, Working Paper Series qt5fc508pt, Department of Economics, UC Santa Cruz.
  5. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
  6. Fisher, Eric O'N., 2006. "The forward premium in a model with heterogeneous prior beliefs," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 48-70, February.
  7. Melvin, Michael & Taylor, Mark P, 2009. "The Crisis in the Foreign Exchange Market," CEPR Discussion Papers 7472, C.E.P.R. Discussion Papers.
  8. Yu-chin Chen & Kwok Ping Tsang, 2013. "What Does the Yield Curve Tell Us about Exchange Rate Predictability?," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 185-205, March.
  9. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April.
  10. repec:dgr:uvatin:20010031 is not listed on IDEAS
  11. Cosmin Ilut, 2009. "Ambiguity Aversion: Implications For The Uncovered Interest Rate Parity Puzzle," 2009 Meeting Papers 328, Society for Economic Dynamics.
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