Working Paper: CEPR ID: DP13463
Authors: Geert Bekaert; George Panayotov
Abstract: We distinguish between ”good” and ”bad” carry trades constructed from G-10 currencies. The good trades exhibit higher Sharpe ratios and sometimes positive return skewness, in contrast to the bad trades that 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.
Keywords: currency carry trade; predictability; currency risk factors
JEL Codes: C23; C53; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Good carry trades (G15) | Higher Sharpe ratios (G19) |
| Exclusion of AUD, JPY, and NOK (G15) | Higher Sharpe ratios (G19) |
| Good carry trades (G15) | Improved return skewness (C46) |
| Composition of currency set (E42) | Nature of carry trade returns (G15) |
| Good carry trades (G15) | Performance not correlated with traditional risk factors (D29) |