Carry Trades and Currency Crashes

Markus Brunnermeier, Stefan Nagel and Lasse Pedersen

No 14473, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper documents that carry traders are subject to crash risk: i.e. exchange rate movements between high-interest-rate and low-interest-rate currencies are negatively skewed. We argue that this negative skewness is due to sudden unwinding of carry trades, which tend to occur in periods in which risk appetite and funding liquidity decrease. Funding liquidity measures predict exchange rate movements, and controlling for liquidity helps explain the uncovered interest-rate puzzle. Carry-trade losses reduce future crash risk, but increase the price of crash risk. We also document excess co-movement among currencies with similar interest rate. Our findings are consistent with a model in which carry traders are subject to funding liquidity constraints.

JEL-codes: E44 F3 F31 G12 (search for similar items in EconPapers)
Date: 2008-11
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mst
Note: AP EFG IFM ME
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Citations: View citations in EconPapers (496)

Published as Carry Trades and Currency Crashes , Markus K. Brunnermeier, Stefan Nagel, Lasse H. Pedersen. in NBER Macroeconomics Annual 2008, Volume 23 , Acemoglu, Rogoff, and Woodford. 2009

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Chapter: Carry Trades and Currency Crashes (2009)
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