Do Peso Problems Explain the Returns to the Carry Trade?

82 Pages Posted: 27 Apr 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)

Multiple version iconThere are 3 versions of this paper

Date Written: January 1, 2010

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 investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates

JEL Classification: F31

Suggested Citation

Burnside, Craig and Eichenbaum, Martin and Kleshchelski, Isaac and Tavares Rebelo, Sergio, Do Peso Problems Explain the Returns to the Carry Trade? (January 1, 2010). Economics Research Initiatives at Duke (ERID) Working Paper No. 45. Available at SSRN: https://ssrn.com/abstract=1596287 or http://dx.doi.org/10.2139/ssrn.1596287

Craig Burnside (Contact Author)

Duke University - Department of Economics ( email )

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University of Glasgow - Department of Economics

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National Bureau of Economic Research (NBER)

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Martin Eichenbaum

Northwestern University ( email )

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National Bureau of Economic Research (NBER)

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Isaac Kleshchelski

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Sergio Tavares Rebelo

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Leverone Hall
Evanston, IL 60208
United States
847-467-2329 (Phone)
847-491-5719 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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