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Currency Carry Trades

In: NBER International Seminar on Macroeconomics 2010

  • Travis Berge
  • Òscar Jordà
  • 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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This chapter was published in:
  • Richard Clarida & Francesco Giavazzi, 2011. "NBER International Seminar on Macroeconomics 2010," NBER Books, National Bureau of Economic Research, Inc, number clar10-1, October.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 12216.
    Handle: RePEc:nbr:nberch:12216
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.org
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    1. Melvin, Michael & Taylor, Mark P, 2009. "The Crisis in the Foreign Exchange Market," CEPR Discussion Papers 7472, C.E.P.R. Discussion Papers.
    2. Lubos Pastor & Robert F. Stambaugh, 2001. "Liquidity Risk and Expected Stock Returns," NBER Working Papers 8462, National Bureau of Economic Research, Inc.
    3. Yin-Wong Cheung & Antonio Garcia Pascual & Menzie David Chinn, 2004. "Empirical Exchange Rate Models of the Nineties; Are Any Fit to Survive?," IMF Working Papers 04/73, International Monetary Fund.
    4. Raffaella Giacomini & Halbert White, 2003. "Tests of Conditional Predictive Ability," Econometrics 0308001, EconWPA.
    5. Eric O'N. Fisher, 2000. "The Forward Premium in a Model with Heterogeneous Prior Beliefs," Working Papers 01-05, Ohio State University, Department of Economics.
    6. Yu-chin Chen & Kwok Ping Tsang, 2009. "What Does the Yield Curve Tell Us About Exchange Rate Predictability?," Working Papers e07-15, Virginia Polytechnic Institute and State University, Department of Economics.
    7. Geert Bekaert & Robert J. Hodrick, 1991. "On Biases in the Measurement of Foreign Exchange Risk Premiums," NBER Working Papers 3861, National Bureau of Economic Research, Inc.
    8. 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.
    9. Cosmin L. Ilut, 2010. "Ambiguity Aversion: Implications for the Uncovered Interest Rate Parity Puzzle," Working Papers 10-53, Duke University, Department of Economics.
    10. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
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