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Does previous carry trade position affect following investors' decision-making and carry returns?

Ziyun Zhang, Su Chen and Bo Li

International Review of Financial Analysis, 2022, vol. 80, issue C

Abstract: This paper builds a two-country model to investigate the relationship between carry trade activity and carry trade return. The two-country model finds that previous carry trade position could positively affect current carry return and current carry trade scale. This positive relationship fosters the asset bubble of high-yielding currency, and the potential for huge losses could also make the carry trader unwind the carry trade position. Based on carry trade panel data from 22 countries and regions, this paper studies the relationship empirically through a panel vector autoregression model. The empirical results find that carry trade position has a significant positive relationship with carry return and carry trade position in following periods. Also, the empirical results suggest that foreign exchange risk could negatively affect carry return and carry trade position. Once the foreign exchange risk increases, carry traders choose smaller carry trade positions.

Keywords: Carry trade return; Carry trade scale; Foreign exchange risk; Panel VAR (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.irfa.2022.102056

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