Working Paper: CEPR ID: DP7345
Authors: Charlotte Christiansen; Angelo Ranaldo; Paul Sderlind
Abstract: This paper suggests a factor model for carry trade strategies where the regression coefficients are allowed to depend on market volatility and liquidity. Empirical results on daily data from 1995 to 2008 show that a typical carry trade strategy has much higher exposure to the stock market and also more mean reversion in volatile periods - and that FX market volatility is a priced risk factor. The findings are robust to various extensions, including using more currencies and other proxies for volatility and liquidity (VIX, TED and a bid-ask spread).
Keywords: carry trade; factor model; smooth transition regression; time varying betas
JEL Codes: F31; G11; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market conditions (P42) | risk exposure (G22) |
| FX market volatility (F31) | carry trade returns (G15) |
| volatile periods (E32) | risk exposure (G22) |