The Carry Trade: Risks and Drawdowns

Critical Finance Review, forthcoming

62 Pages Posted: 26 Aug 2014 Last revised: 4 Apr 2017

See all articles by Kent D. Daniel

Kent D. Daniel

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Zhongjin Lu

University of Georgia - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 11, 2016

Abstract

We find important differences in dollar-based and dollar-neutral G10 carry trades. Dollar-neutral trades have positive average returns, are highly negatively skewed, are correlated with risk factors, and exhibit considerable downside risk. In contrast, a diversified dollar-carry portfolio has a higher average excess return, a higher Sharpe ratio, minimal skewness, is uncorrelated with standard risk-factors, and exhibits no downside risk. Distributions of drawdowns and maximum losses from daily data indicate a role for time-varying autocorrelation in determining negative skewness at longer horizons.

Keywords: currency carry trade, currency risk factors, market efficiency

JEL Classification: F31, G12, G15

Suggested Citation

Daniel, Kent D. and Hodrick, Robert J. and Lu, Zhongjin, The Carry Trade: Risks and Drawdowns (March 11, 2016). Critical Finance Review, forthcoming. Available at SSRN: https://ssrn.com/abstract=2486275 or http://dx.doi.org/10.2139/ssrn.2486275

Kent D. Daniel (Contact Author)

Columbia Business School - Finance and Economics ( email )

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HOME PAGE: http://kentdaniel.net/

National Bureau of Economic Research (NBER)

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Robert J. Hodrick

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

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New York, NY 10016-4309
United States

Zhongjin Lu

University of Georgia - Department of Finance ( email )

Terry College of Business
Athens, GA 30602-6254
United States

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