Do Peso Problems Explain the Returns to the Carry Trade?
57 Pages Posted: 9 Jun 2008 Last revised: 1 Oct 2010
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Do Peso Problems Explain the Returns to the Carry Trade?
Do Peso Problems Explain the Returns to the Carry Trade?
Do Peso Problems Explain the Returns to the Carry Trade?
Date Written: June 2008
Abstract
We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We argue that these payoffs reflect a peso problem. The underlying peso event features high values of the stochastic discount factor rather than very large negative payoffs.
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