Hostname: page-component-586b7cd67f-2plfb Total loading time: 0 Render date: 2024-11-26T05:58:28.088Z Has data issue: false hasContentIssue false
  • English
  • Français

Good Carry, Bad Carry

Published online by Cambridge University Press:  21 October 2019

Geert Bekaert  and
George Panayotov Open the ORCID record for George Panayotov [Opens in a new window]
Geert Bekaert
Affiliation:
Bekaert, [email protected], Columbia University Business School
George Panayotov*
Affiliation:
Panayotov, [email protected], Hong Kong University of Science and Technology School of Business
*
Panayotov (corresponding author), [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

We distinguish between “good” and “bad” carry trades constructed from Group of Ten (G-10) currencies. The good trades exhibit higher Sharpe ratios and sometimes positive return skewness, in contrast to the bad trades, which have both substantially lower Sharpe ratios and highly negative return skewness. Surprisingly, good trades do not involve the most typical carry currencies like the Australian dollar and Japanese yen. The distinction between good and bad carry trades significantly alters our understanding of currency carry trade returns, and invalidates, for example, explanations invoking return skewness and crash risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 4 , June 2020 , pp. 1063 - 1094
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We acknowledge many fruitful suggestions by Raymond Kan and discussions with Gurdip Bakshi, Utpal Bhattacharya, Steve Riddiough, Giorgio Valente, and Jialin Yu. Participants at the 2016 Annual Conference in International Finance at City University of Hong Kong; the 2016 Bank of England, Banca d’Italia, and 6th European Central Bank Workshop on Financial Determinants of Foreign Exchange Rates; the 2018 Vienna Symposium on Foreign Exchange Markets; and seminars at Nanyang Technology University, the Sabanci Center in Istanbul, the Shanghai Advanced Institute of Finance, the University of New South Wales, and Xiamen University provided helpful insights. Any remaining errors are our responsibility alone. Panayotov acknowledges support from the Hong Kong Research Grants Council (grant no. 16505715).

References

Adrian, T.; Etula, E.; and Shin, H. S.. “Risk Appetite and Exchange Rates.” Staff Reports, Federal Reserve Bank of New York (2015).Google Scholar
Ang, A., and Chen, J.. “Yield Curve Predictors of Foreign Exchange Returns.” Working Paper, Columbia University (2010).CrossRefGoogle Scholar
Annaert, J.; Van Osselaer, S.; and Verstraete, B.. “Performance Evaluation of Portfolio Insurance Strategies Using Stochastic Dominance Criteria.” Journal of Banking and Finance, 33 (2009), 272–280.CrossRefGoogle Scholar
Bakshi, G., and Panayotov, G.. “Predictability of Currency Carry Trades and Asset Pricing Implications.” Journal of Financial Economics, 110 (2013), 139–163.CrossRefGoogle Scholar
Barroso, P., and Santa-Clara, P.. “Beyond the Carry Trade: Optimal Currency Portfolios.” Journal of Financial and Quantitative Analysis, 50 (2014), 1037–1056.CrossRefGoogle Scholar
Bekaert, G., and Hodrick, R.. International Financial Management. 2nd ed.Upper Saddle River, NJ: Prentice Hall (2012).Google Scholar
Bekaert, G.; Wei, M.; and Xing, Y.. “Uncovered Interest Rate Parity and the Term Structure.” Journal of International Money and Finance, 26 (2007), 1038–1069.CrossRefGoogle Scholar
Brunnermeier, M.; Nagel, S.; and Pedersen, L.. “Carry Trades and Currency Crashes.” NBER Macroeconomics Annual, 23 (2009), 313–347.CrossRefGoogle Scholar
Burnside, C.; Eichenbaum, M.; Kleshchelski, I.; and Rebelo, S.. “Do Peso Problems Explain the Returns to the Carry Trade?” Review of Financial Studies, 24 (2011), 853–891.CrossRefGoogle Scholar
Christiansen, C.; Ranaldo, A.; and Söderlind, P.. “The Time-Varying Systematic Risk of Carry Trade Strategies.” Journal of Financial and Quantitative Analysis, 46 (2011), 1107–1125.CrossRefGoogle Scholar
Clarida, R.; Davis, J.; and Pedersen, N.. “Currency Carry Trade Regimes: Beyond the Fama Regression.” Journal of International Money and Finance, 28 (2009), 1375–1389.CrossRefGoogle Scholar
Clark, T., and West, K.. “Approximately Normal Tests for Equal Predictive Accuracy in Nested Models.” Journal of Econometrics, 138 (2007), 291–311.CrossRefGoogle Scholar
Cochrane, J.Asset Pricing. Princeton, NJ: Princeton University Press (2005).Google Scholar
Daniel, K.; Hodrick, R.; and Lu, Z.. “The Carry Trade: Risks and Drawdowns.” Critical Finance Review, 6 (2017), 211–262.CrossRefGoogle Scholar
Hassan, T.“Country Size, Currency Unions, and International Asset Returns.” Journal of Finance, 68 (2013), 2269–2308.CrossRefGoogle Scholar
Hassan, T., and Mano, R.. “Forward and Spot Exchange Rates in a Multi-Currency World.” Quarterly Journal of Economics, 134 (2019), 397–450.CrossRefGoogle Scholar
Hodrick, R.“Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement.” Review of Financial Studies, 5 (1992), 357–386.CrossRefGoogle Scholar
Jagannathan, R., and Wang, Z.. “The Conditional CAPM and the Cross-Section of Expected Returns.” Journal of Finance, 51 (1996), 3–53.CrossRefGoogle Scholar
Jobson, J. D., and Korkie, B. M.. “Performance Hypothesis Testing with the Sharpe and Treynor Measures.” Journal of Finance, 36 (1981), 889–908.CrossRefGoogle Scholar
Jordà, O., and Taylor, A.. “The Carry Trade and Fundamentals: Nothing to Fear but FEER Itself.” Journal of International Economics, 88 (2012), 74–90.CrossRefGoogle Scholar
Jurek, J.“Crash-Neutral Currency Carry Trades.” Journal of Financial Economics, 113 (2014), 325–347.CrossRefGoogle Scholar
Koijen, R.; Moskowitz, T.; Pedersen, L.; and Vrugt, E.. “Carry.” Working Paper, London Business School (2015).CrossRefGoogle Scholar
Ledoit, O., and Wolf, M.. “Robust Performance Hypothesis Testing with the Sharpe Ratio.” Journal of Empirical Finance, 15 (2008), 850–859.CrossRefGoogle Scholar
Lettau, M.; Maggiori, M.; and Weber, M.. “Conditional Risk Premia in Currency Markets and Other Asset Classes.” Journal of Financial Economics, 114 (2015), 197–225.CrossRefGoogle Scholar
Lustig, H.; Roussanov, N.; and Verdelhan, A.. “Common Risk Factors in Currency Markets.” Review of Financial Studies, 24 (2011), 3731–3777.CrossRefGoogle Scholar
Lustig, H.; Roussanov, N.; and Verdelhan, A.. “Countercyclical Currency Risk Premia.” Journal of Financial Economics, 111 (2014), 527–553.CrossRefGoogle Scholar
Maggiori, M.“The U.S. Dollar Safety Premium.” Working Paper, Harvard University (2013).Google Scholar
Maurer, T.; Tô, T.-D.; and Tran, N.-K.. “Pricing Risks Across Currency Denominations.” Management Science, 65 (2019), 5308–5336.CrossRefGoogle Scholar
Melvin, M., and Taylor, M.. “The Crisis in the Foreign Exchange Market.” Journal of International Money and Finance, 28 (2009), 1317–1330.CrossRefGoogle Scholar
Memmel, C.“Performance Hypothesis Testing with the Sharpe Ratio.” Finance Letters, 1 (2003), 21–23.Google Scholar
Menkhoff, L.; Sarno, L.; Schmeling, M.; and Schrimpf, A.. “Carry Trades and Global Foreign Exchange Volatility.” Journal of Finance, 67 (2012), 681–718.CrossRefGoogle Scholar
Ready, R.; Roussanov, N.; and Ward, C.. “Commodity Trade and the Carry Trade: A Tale of Two Countries.” Journal of Finance, 72 (2017), 2629–2684.CrossRefGoogle Scholar
Supplementary material: File

Bekaert and Panayotov supplementary material

Bekaert and Panayotov supplementary material

Download Bekaert and Panayotov supplementary material(File)
File 144.1 KB