Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation

39 Pages Posted: 11 Sep 2006 Last revised: 25 Aug 2009

See all articles by Christian Wagner

Christian Wagner

WU Vienna University of Economics and Business; Vienna Graduate School of Finance (VGSF)

Date Written: March 1, 2008

Abstract

In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited 'forward bias puzzle' originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia and generates economic value when applied in multi-currency portfolios.

Keywords: Exchange rates, Uncovered interest parity, Forward bias puzzle, Risk-premia, Carry-trade, Economic value

JEL Classification: F31

Suggested Citation

Wagner, Christian, Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation (March 1, 2008). EFA 2008 Athens Meetings Paper. Available at SSRN: https://ssrn.com/abstract=921339 or http://dx.doi.org/10.2139/ssrn.921339

Christian Wagner (Contact Author)

WU Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

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