Cross-Asset Return Predictability: Carry Trades, Stocks and Commodities
61 Pages Posted: 7 Feb 2015 Last revised: 18 Sep 2015
Date Written: September 16, 2015
Equity returns predict carry trade profits from shorting low interest rate currencies. Commodity price changes predict profits from longing high interest rate currencies. The gradual information diffusion hypothesis (Hong & Stein, 1999; Hong, Torous, & Valkanov, 2007) provides a ready explanation for these predictability results. These results cannot be explained by time-varying risk premia as stock returns and commodity price changes significantly predict negative carry trade profits. The predictability is one-directional, from commodities to high interest rate currencies, from commodities to stocks and from stocks to low interest rate currencies.
Keywords: Carry Trade; Gradual Information Diffusion; Return Predictability, Safe-haven Currencies, Time-varying Risk Premium, Vector Auto Regression
JEL Classification: G11, G14, F31
Suggested Citation: Suggested Citation