Working Paper: NBER ID: w20433
Authors: Kent Daniel; Robert J. Hodrick; Zhongjin Lu
Abstract: We examine carry trade returns formed from the G10 currencies. Performance attributes depend on the base currency. Dynamically spread-weighting and risk-rebalancing positions improves performance. Equity, bond, FX, volatility, and downside equity risks cannot explain profitability. Dollar-neutral carry trades exhibit insignificant abnormal returns, while the dollar exposure part of the carry trade earns significant abnormal returns with little skewness. Downside equity market betas of our carry trades are not significantly different from unconditional betas. Hedging with options reduces but does not eliminate abnormal returns. Distributions of drawdowns and maximum losses from daily data indicate the importance of time-varying autocorrelation in determining the negative skewness of longer horizon returns.
Keywords: carry trade; currency markets; drawdowns; risk exposure
JEL Codes: F31; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| base currency (F31) | performance of carry trades (G15) |
| trading strategy adjustments (F16) | enhanced returns (G11) |
| dollar exposure (F31) | profitability (L21) |
| downside equity market betas (G12) | returns (Y60) |
| hedging with options (G13) | abnormal returns (G14) |