Do Peso Problems Explain the Returns to the Carry Trade?

57 Pages Posted: 9 Jun 2008 Last revised: 1 Oct 2010

See all articles by A. Craig Burnside

A. Craig Burnside

Duke University - Department of Economics; University of Glasgow - Department of Economics; National Bureau of Economic Research (NBER)

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Isaac Kleshchelski

Northwestern University

Sergio T. Rebelo

Northwestern University - Kellogg School of Management; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

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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.

Suggested Citation

Burnside, Craig and Eichenbaum, Martin and Kleshchelski, Isaac and Tavares Rebelo, Sergio, Do Peso Problems Explain the Returns to the Carry Trade? (June 2008). NBER Working Paper No. w14054. Available at SSRN: https://ssrn.com/abstract=1142226

Craig Burnside (Contact Author)

Duke University - Department of Economics ( email )

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Martin Eichenbaum

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Isaac Kleshchelski

Northwestern University ( email )

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Sergio Tavares Rebelo

Northwestern University - Kellogg School of Management ( email )

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847-491-5719 (Fax)

Centre for Economic Policy Research (CEPR)

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United Kingdom

National Bureau of Economic Research (NBER)

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