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Destabilizing carry trades

Author

Listed:
  • Guillaume Plantin

    (Département d'économie)

  • Hyun Song Shin

    (Princeton University)

Abstract

We offer a model of currency carry trades in which carry traders generate self-sustained excess returns if they coordinate on supplying excessive capital to a target economy. The interest-rate differential between their funding currency and the target currency is their coordination device. Such self-fulfilling pro table currency trades arise when the central bank of the target economy ignores the impact of carry-trade in flows on domestic asset prices, and responds only to their effect on inflation. We solve for a unique equilibrium that exhibits the classic pattern of the carry-trade recipient currency appreciating for extended periods, punctuated by sharp falls.

Suggested Citation

  • Guillaume Plantin & Hyun Song Shin, 2015. "Destabilizing carry trades," Sciences Po publications info:hdl:2441/6skkqt46r78, Sciences Po.
    • Handle: RePEc:spo:wpmain:info:hdl:2441/6skkqt46r78qk9i6iliq48n6bm
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    Cited by:

    1. Breedon, Francis & Pétursson, Thórarinn G. & Vitale, Paolo, 2023. "The currency that came in from the cold: Capital controls and the information content of order flow," Journal of International Money and Finance, Elsevier, vol. 138(C).

    More about this item

    Keywords

    Currency Carry Trades; Inflation Targeting; Financial Instability;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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