Do Currency Fundamentals Matter for Currency Speculators?

Masahiro Nozaki

No 2010/039, IMF Working Papers from International Monetary Fund

Abstract: The answer seems affirmative. We compare currency carry trades with an investment strategy based on currency fundamentals: taking a long (short) position in undervalued (overvalued) currencies. Carry trades have high risk-adjusted returns, but are subject to "crash risk." In contrast, the fundamental strategy has lower risk-adjusted returns, but is less prone to crash risk, because the realization of crash risk coincides with corrections towards fundamentals. In particular, the fundamental strategy outperformed carry trades during the recent global financial crisis. Building on these results, we present early warning indicators for potential turbulence in the currency market.

Keywords: WP; carry trade strategy; Danish krone; pound sterling; currency speculation; carry trades; currency fundamentals; currency speculation strategy; Sharpe ratio; commodity-currency portfolio; currency carry trades; Currencies; Real effective exchange rates; Exchange rates; Exchange rate adjustments; Purchasing power parity; Global (search for similar items in EconPapers)
Pages: 34
Date: 2010-02-01
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Citations: View citations in EconPapers (9)

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