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Currency Carry Trades

  • Travis J. 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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File URL: http://www.nber.org/papers/w16491.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16491.

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Date of creation: Oct 2010
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Publication status: published as Travis Berge & �scar Jord� & Alan M. Taylor, 2011. "Currency Carry Trades," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 7(1), pages 357 - 388.
Handle: RePEc:nbr:nberwo:16491
Note: AP IFM
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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. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  3. 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.
  4. Luboš Pástor & Robert F. Stambaugh, . "Liquidity Risk and Expected Stock Returns," CRSP working papers 531, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  5. Yin-Wong Cheung & Menzie D. Chinn & Antonio Garcia Pascual, 2002. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," NBER Working Papers 9393, National Bureau of Economic Research, Inc.
  6. Raffaella Giacomini & Halbert White, 2006. "Tests of Conditional Predictive Ability," Econometrica, Econometric Society, vol. 74(6), pages 1545-1578, November.
  7. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
  8. 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.
  9. Cosmin Ilut, 2009. "Ambiguity Aversion: Implications For The Uncovered Interest Rate Parity Puzzle," 2009 Meeting Papers 328, Society for Economic Dynamics.
  10. 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.
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