The Revenge of Purchasing Power Parity on Carry Trades during Crises
Marie Brière () and
Bastien Drut
No 09-013.RS, Working Papers CEB from ULB -- Universite Libre de Bruxelles
Abstract:
Empirical evidence shows that fundamental models have produced disappointing results over the past 20 years while carry trade strategies have performed superbly. But the real picture is much more complex. In fact, the track records of both strategies have varied considerably. This article shows that they have actually alternated between periods of profitability and underperformance. It also shows that when carry trade strategies perform well, fundamental strategies do poorly, and vice versa. Crises appear to play a significant role in the alternation of investment styles on currency markets. In contrast to carry trades, fundamental strategies perform remarkably well in crises. A portfolio that rotates between these two types of strategies, based on a risk aversion indicator such as implied equity volatility, would substantially outperform a pure carry trade strategy and would be robust to crises.
Keywords: carry trades; exchange rates; financial crisis; risk aversion; investment strategy; purchasing power parity; fundamentals model. (search for similar items in EconPapers)
JEL-codes: F31 G11 G15 (search for similar items in EconPapers)
Pages: 27 p.
Date: 2009
New Economics Papers: this item is included in nep-cba and nep-ifn
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Citations: View citations in EconPapers (11)
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