Foreign exchange risk and the predictability of carry trade returns

Gino Cenedese (), Lucio Sarno and Ilias Tsiakas

Journal of Banking & Finance, 2014, vol. 42, issue C, 302-313

Abstract: This paper provides an empirical investigation of the time-series predictive ability of foreign exchange risk measures on the return to the carry trade, a popular investment strategy that borrows in low-interest currencies and lends in high-interest currencies. Using quantile regressions, we find that higher market variance is significantly related to large future carry trade losses, which is consistent with the unwinding of the carry trade in times of high volatility. The decomposition of market variance into average variance and average correlation shows that the predictive power of market variance is primarily due to average variance since average correlation is not significantly related to carry trade returns. Finally, a new version of the carry trade that conditions on market variance generates performance gains net of transaction costs.

Keywords: Exchange rates; Carry trade; Market variance; Average variance; Average correlation; Quantile regression (search for similar items in EconPapers)
JEL-codes: F31 G15 G17 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (48)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0378426614000545
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Foreign Exchange Risk and the Predictability of Carry Trade Returns (2014)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:42:y:2014:i:c:p:302-313

DOI: 10.1016/j.jbankfin.2014.01.040

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().