Working Paper: NBER ID: w25420
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 trades; Sharpe ratios; return skewness
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 |
|---|---|
| Reducing the set of G10 currencies to exclude AUD, JPY, and NOK (F31) | Improved Sharpe ratios (G40) |
| Reducing the set of G10 currencies to exclude AUD, JPY, and NOK (F31) | Improved skewness in carry trades (G15) |
| Good carry trades (excluding AUD, JPY, and NOK) (G15) | Higher average returns (G11) |
| Good carry trades (excluding AUD, JPY, and NOK) (G15) | Better risk-return profiles (G11) |
| Bad carry trades (including AUD, JPY, and NOK) (F31) | Lower Sharpe ratios (G40) |
| Bad carry trades (including AUD, JPY, and NOK) (F31) | More negatively skewed returns (C46) |