29 Pages Posted: 25 Oct 2010
Date Written: October 2010
A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.
Suggested Citation: Suggested Citation
Berge, Travis J. and Jorda, Oscar and Taylor, Alan M., Currency Carry Trades (October 2010). NBER Working Paper No. w16491. Available at SSRN: https://ssrn.com/abstract=1696423
By Ewe-ghee Lim