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The Time-Varying Systematic Risk of Carry Trade Strategies

Listed author(s):
  • Christiansen, Charlotte
  • Ranaldo, Angelo
  • Söderlind, Paul

This paper suggests a factor model for carry trade strategies where the regression coefficients are allowed to depend on market volatility and liquidity. Empirical results on daily data from 1995 to 2008 show that a typical carry trade strategy has much higher exposure to the stock market and also more mean reversion in volatile periods - and that FX market volatility is a priced risk factor. The findings are robust to various extensions, including using more currencies and other proxies for volatility and liquidity (VIX, TED and a bid-ask spread).

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7345.

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Date of creation: Jun 2009
Handle: RePEc:cpr:ceprdp:7345
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  3. Angelo Ranaldo & Paul Söderlind, 2010. "Safe Haven Currencies," Review of Finance, European Finance Association, vol. 14(3), pages 385-407.
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  6. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347 National Bureau of Economic Research, Inc.
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  10. Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
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  17. Bansal, Ravi & Dahlquist, Magnus, 1999. "The Forward Premium Puzzle: Different Tales from Developed and Emerging Economies," CEPR Discussion Papers 2169, C.E.P.R. Discussion Papers.
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  19. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
  20. Menkhoff, Lukas & Sarno, Lucio & Schmeling, Maik & Schrimpf, Andreas, 2011. "Carry Trades and Global Foreign Exchange Volatility," CEPR Discussion Papers 8291, C.E.P.R. Discussion Papers.
  21. Leon, Hyginus & Sarno, Lucio & Valente, Giorgio, 2006. "Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle," CEPR Discussion Papers 5527, C.E.P.R. Discussion Papers.
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  24. Roll, Richard, 1984. " A Simple Implicit Measure of the Effective Bid-Ask Spread in an Efficient Market," Journal of Finance, American Finance Association, vol. 39(4), pages 1127-1139, September.
  25. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2004. "The Cross-Section of Volatility and Expected Returns," NBER Working Papers 10852, National Bureau of Economic Research, Inc.
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  27. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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