The Forward Premium Bias, Carry Trade Return and the Risks of Volatility and Liquidity

60 Pages Posted: 4 Jun 2016

See all articles by Ali Shehadeh

Ali Shehadeh

Queen's University Belfast - Finance

Youwei Li

Hull University Business School

Michael Moore

University of Warwick - Warwick Business School

Date Written: May 2016

Abstract

In this paper, we analyse the relationship between the currency carry return and volatility and liquidity risk factors. We find that both categories of risk factors are relevant to understanding and explaining carry return, with an outperformance for volatility ones especially the global FX volatility risk factor. Consistent with the poor performance of currency carry trades during high FX volatility regime, we also show that the well-established negative slope coefficient in the Fama regression tends to be more positive and even above unity in times of high FX volatility. The paper, overall, contributes to the risk-based solution of the forward premium bias puzzle.

Keywords: FX rates, Currency carry trade, Forward-bias puzzle, FX risk premium

JEL Classification: F31, F41, G11, G15, E44

Suggested Citation

Shehadeh, Ali and Li, Youwei and Moore, Michael John, The Forward Premium Bias, Carry Trade Return and the Risks of Volatility and Liquidity (May 2016). Available at SSRN: https://ssrn.com/abstract=2789141 or http://dx.doi.org/10.2139/ssrn.2789141

Ali Shehadeh

Queen's University Belfast - Finance ( email )

United Kingdom

Youwei Li (Contact Author)

Hull University Business School ( email )

University of Hull
Hull, HU6 7RX
United Kingdom

Michael John Moore

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

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