The Carry Trade: Risks and Drawdowns

65 Pages Posted: 3 Sep 2014

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: August 2014

Abstract

We examine carry trade returns formed from the G10 currencies. Performance attributes depend on the base currency. Dynamically spread-weighting and risk-rebalancing positions improves performance. Equity, bond, FX, volatility, and downside equity risks cannot explain profitability. Dollar-neutral carry trades exhibit insignificant abnormal returns, while the dollar exposure part of the carry trade earns significant abnormal returns with little skewness. Downside equity market betas of our carry trades are not significantly different from unconditional betas. Hedging with options reduces but does not eliminate abnormal returns. Distributions of drawdowns and maximum losses from daily data indicate the importance of time-varying autocorrelation in determining the negative skewness of longer horizon returns.

Suggested Citation

Daniel, Kent D. and Hodrick, Robert J. and Lu, Zhongjin, The Carry Trade: Risks and Drawdowns (August 2014). NBER Working Paper No. w20433. Available at SSRN: https://ssrn.com/abstract=2490841

Kent D. Daniel (Contact Author)

Columbia Business School - Finance and Economics ( email )

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National Bureau of Economic Research (NBER)

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Robert J. Hodrick

Columbia Business School - Finance and Economics ( email )

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National Bureau of Economic Research (NBER)

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Zhongjin Lu

University of Georgia - Department of Finance ( email )

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

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