Working Paper: CEPR ID: DP15052
Authors: Pohsuan Hsu; Mark Taylor; Zigan Wang
Abstract: We carry out a large-scale investigation of the out-of-sample profitability of in-sample profitable carry trade strategies, using foreign exchange data for 48 countries spanning a period from 1983 to 2015 and employing reality check and stepwise tests to correct for data-snooping bias (the factor of luck in model selection). Carry trade strategies chosen as profitable in one period are generally not profitable in an ensuing out-of-sample sample period, especially after correcting for data-snooping, and even after allowing for learning and stop-loss strategies. Any evidence of consistency in carry trade profitability that is found is concentrated in a relatively brief historical period, 2001-2005. We further investigate particular currency pairs that may drive the out-of-sample profitability during this period, and find their performance to be unstable in general. Our findings thus highlight the instability and the factor of luck in generating profits from carry trades.
Keywords: Foreign Exchange; Carry Trade; Data Snooping Bias
JEL Codes: F31; C53; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| carry trade strategies deemed profitable in one period (G15) | do not maintain profitability in subsequent out-of-sample periods (E11) |
| strategies that yielded positive returns in earlier periods (e.g., 1984-1991) (E65) | did not show significant profits in later periods (e.g., 1992-1999) (N22) |
| some strategies appear profitable in the 1992-1999 period (G11) | do not necessarily sustain profits in the following years (D25) |
| factors such as luck in strategy selection and market conditions (L19) | inherent instability in carry trade profitability (F32) |
| specific currency pairs contributing to profitability during the 2001-2005 period (F31) | performance tends to be unstable (D29) |