Carry Trades and Risk
A. Craig Burnside
Duke University - Department of Economics; University of Glasgow - Department of Economics; National Bureau of Economic Research (NBER)
NBER Working Paper No. w17278
Carry trades, in which an investor borrows a low interest rate currency and lends a high interest rate currency, have been profitable historically. The risk exposure of carry traders might explain their high returns, but conventional models of risk do not work because traditional risk factors, used to price the stock market, do not price currency returns. Less traditional factors that are more successful in explaining currency returns, are, however, unsuccessful in explaining the returns to the stock market. More exotic models of "crisis risk" are another possibility, but I show that any time-variation in the exposure of the carry trade to market risk has been insufficient, in sample, to explain the average returns earned by carry traders. Instead, peso events remain a candidate explanation of the returns to the carry trade.
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Number of Pages in PDF File: 38working papers series
Date posted: August 8, 2011
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