43 Pages Posted: 18 Apr 2012 Last revised: 1 May 2016
Date Written: June 24, 2012
We test the relevance of technical and fundamental variables in forming currency portfolios. Carry, momentum and reversal all contribute to portfolio performance, whereas the real exchange rate and the current account do not. The resulting optimal portfolio outperforms the carry trade and other naive benchmarks in an extensive 16 year out-of-sample test. Its returns are not explained by risk and are valuable to diversified investors holding stocks and bonds. Exposure to currencies increases the Sharpe ratio of diversified portfolios by 0.5 on average, while reducing crash risk. We argue that currency returns are an anomaly which is gradually being corrected as hedge fund capital increases.
The appendix may be found here: http://ssrn.com/abstract=2771667.
Keywords: forward rate premium, carry trade, currency market, optimal portfolios
JEL Classification: F31, G11, G12
Suggested Citation: Suggested Citation
Barroso, Pedro and Santa-Clara, Pedro, Beyond the Carry Trade: Optimal Currency Portfolios (June 24, 2012). Journal of Financial and Quantitative Analysis (JFQA), Vol. 50, No. 5, 2015. Available at SSRN: https://ssrn.com/abstract=2041460 or http://dx.doi.org/10.2139/ssrn.2041460
By Karen Lewis