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Do Peso Problems Explain the Returns to the Carry Trade?

Author

Listed:
  • A. Craig Burnside
  • Martin Eichenbaum
  • Isaac Kleshchelski
  • Sergio T. Rebelo

Abstract

We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates

Suggested Citation

  • A. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio T. Rebelo, 2010. "Do Peso Problems Explain the Returns to the Carry Trade?," Working Papers 10-44, Duke University, Department of Economics.
    • Handle: RePEc:duk:dukeec:10-44
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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