Working Paper: NBER ID: w12916
Authors: Craig Burnside; Martin Eichenbaum; Sergio Rebelo
Abstract: The carry trade strategy involves selling forward currencies that are at a forward premium and buying forward currencies that are at a forward discount. We compare the payoffs to the carry trade applied to two different portfolios. The first portfolio consists exclusively of developed country currencies. The second portfolio includes the currencies of both developed countries and emerging markets. Our main empirical findings are as follows. First, including emerging market currencies in our portfolio substantially increases the Sharpe ratio associated with the carry trade. Second, bid-ask spreads are two to four times larger in emerging markets than in developed countries. Third and most dramatically, the payoffs to the carry trade for both portfolios are uncorrelated with returns to the U.S. stock market.
Keywords: currency speculation; carry trade; emerging markets; Sharpe ratio
JEL Codes: F3; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Including emerging market currencies (F31) | Sharpe ratio of carry trade portfolio (G19) |
| Ignoring bid-ask spreads (G19) | Profitability of carry trade strategies (G15) |
| Carry trade payoffs (G19) | U.S. stock market returns (G17) |