The Time-Varying Systematic Risk of Carry Trade Strategies

35 Pages Posted: 14 Mar 2010

See all articles by Charlotte Christiansen

Charlotte Christiansen

Aarhus University - CREATES

Angelo Ranaldo

University of St. Gallen; Swiss Finance Institute

Paul Söderlind

University of St. Gallen

Multiple version iconThere are 3 versions of this paper

Date Written: February 5, 2010

Abstract

We explain the currency carry trade performance using an asset pricing model in which factor loadings are regime-dependent rather than constant. Empirical results show that a typical carry trade strategy has much higher exposure to the stock market and is mean-reverting in regimes of high FX volatility. The findings are robust to various extensions. Our regime-dependent pricing model provides significantly smaller pricing errors than a traditional model. Thus, the carry trade performance is better explained by a time-varying systematic risk that increases in volatile markets, suggesting a partial resolution of the Uncovered Interest Rate parity puzzle.

Keywords: carry trades, factor model, FX volatility, liquidity, smooth transition regression, time-varying betas

JEL Classification: F31, G15, G11

Suggested Citation

Christiansen, Charlotte and Ranaldo, Angelo and Söderlind, Paul, The Time-Varying Systematic Risk of Carry Trade Strategies (February 5, 2010). Available at SSRN: https://ssrn.com/abstract=1569558 or http://dx.doi.org/10.2139/ssrn.1569558

Charlotte Christiansen

Aarhus University - CREATES ( email )

Fuglesangs Alle 4
Aarhus V, DK 8210
Denmark

Angelo Ranaldo (Contact Author)

University of St. Gallen ( email )

School of Finance
Unterer Graben 21
St. Gallen, 9000
Switzerland
+41712247010 (Phone)

HOME PAGE: http://fin-sr.unisg.ch

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland
+41796637711 (Phone)

HOME PAGE: http://www.sfi.ch/de/about-us/news/hsg-faculty-members

Paul Söderlind

University of St. Gallen ( email )

Rosenbergstrasse 52
St. Gallen, 9000
Switzerland
+41 71 224 7064 (Phone)
+41 71 224 7088 (Fax)

HOME PAGE: http://https://sites.google.com/site/paulsoderlindecon/home

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
379
Abstract Views
1,955
Rank
17,384
PlumX Metrics