The Time-Varying Systematic Risk of Carry Trade Strategies
33 Pages Posted: 26 Aug 2009
Date Written: June 2009
This paper suggests a factor model for carry trade strategies where the regression coefficients are allowed to depend on market volatility and liquidity. Empirical results on daily data from 1995 to 2008 show that a typical carry trade strategy has much higher exposure to the stock market and also more mean reversion in volatile periods - and that FX market volatility is a priced risk factor. The findings are robust to various extensions, including using more currencies and other proxies for volatility and liquidity (VIX, TED and a bid-ask spread).
Keywords: carry trade, factor model, smooth transition regression, time-varying betas
JEL Classification: F31, G11, G15
Suggested Citation: Suggested Citation