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Do Peso Problems Explain the Returns to the Carry Trade?

  • A. Craig Burnside
  • Martin S. Eichenbaum
  • Isaac Kleshchelski
  • Sergio Rebelo

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 argue that these payoffs reflect a peso problem. The underlying peso event features high values of the stochastic discount factor rather than very large negative payoffs.

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File URL: http://www.nber.org/papers/w14054.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14054.

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Date of creation: Jun 2008
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Publication status: published as Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2011. "Do Peso Problems Explain the Returns to the Carry Trade?," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 853-891.
Handle: RePEc:nbr:nberwo:14054
Note: AP EFG IFM ME
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Altig, David E & Christiano, Lawrence J. & Eichenbaum, Martin & Lindé, Jesper, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," CEPR Discussion Papers 4858, C.E.P.R. Discussion Papers.
  2. Clinton, Kevin, 1988. "Transactions Costs and Covered Interest Arbitrage: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 358-70, April.
  3. A. Craig Burnside, 2007. "Empirical Asset Pricing and Statistical Power in the Presence of Weak Risk Factors," NBER Working Papers 13357, National Bureau of Economic Research, Inc.
  4. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices 09-191, Review of Economic Dynamics.
  5. Taylor, Mark P, 1987. "Covered Interest Parity: A High-Frequency, High-Quality Data Study," Economica, London School of Economics and Political Science, vol. 54(216), pages 429-38, November.
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