The Returns to Currency Speculation

Craig Burnside (), Martin Eichenbaum (), Isaac Kleshchelski and Sergio Rebelo ()

No 12489, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Currencies that are at a forward premium tend to depreciate. This 'forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. In practice bid-ask spreads are an increasing function of order size. In addition, there is price pressure, i.e. exchange rates are an increasing function of net order flow. Together these frictions greatly reduce the profitability of currency speculation strategies. In fact, the marginal Sharpe ratio associated with currency speculation can be zero even though the average Sharpe ratio is positive.

JEL-codes: E24 F31 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fin, nep-fmk, nep-ifn, nep-knm, nep-mac, nep-mon, nep-mst and nep-rmg
Date: 2006-08
Note: EFG IFM AP
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Related works:
Working Paper: The Returns to Currency Speculation (2006)
Working Paper: The Returns to Currency Speculation (2006)
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