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Impact of macro-economic surprises on carry trade activity

Michael Hutchison () and Vladyslav Sushko ()

Journal of Banking & Finance, 2013, vol. 37, issue 4, 1133-1147

Abstract: Can official news and policy announcements affect foreign exchange speculation? A widespread speculative strategy in foreign exchange markets is carry trade. This paper explores the links between macro-economic news and foreign exchange options to identify macro-economic fundamentals most relevant to the pricing of downside risk – measured by risk reversals options contracts – to carry trade activity. Focusing primarily on the Japanese yen carry trade, we identify a significant impact of macro-economic surprises on dollar/yen risk reversals. The effect is sizeable, with news related to bilateral trade balance of particular concern. Moreover, there is a close link between risk reversals and speculative futures positions in Japanese yen. This allows us to quantify a substantial effect of macro-economic news on carry trade activity, with the cost of hedging as the transmission mechanism.

Keywords: Macro-economic news; Risk reversals; Foreign exchange futures; Carry trade (search for similar items in EconPapers)
JEL-codes: C22 F31 G14 (search for similar items in EconPapers)
Date: 2013
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Handle: RePEc:eee:jbfina:v:37:y:2013:i:4:p:1133-1147