Cross-Asset Return Predictability: Carry Trades, Stocks and Commodities

Abstract

Bakshi and Panayotov (2013) find that commodity price changes predict profits from longing high interest rate currencies (long leg profits) up to three months later. We find that equity returns also predict carry trade profits, but from shorting low interest rate currencies (short leg profits). Equity effects appear to be slightly faster than commodity effects, as equity price rises predict higher short leg profits over the next two months. The predictability is one-directional from commodities and stocks to carry trades. Our evidence supports gradual information diffusion, rather than time-varying risk premia, as the most likely explanation for the predictability results.

Keywords: Carry Trade, Return Predictability, Safe-haven Currencies, Gradual Information Diffusion

JEL Classification: G11, G14, F31