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The Returns to Currency Speculation

61 Pages Posted: 1 Dec 2006 Last revised: 18 Aug 2010

A. Craig Burnside

Duke University - Department of Economics; University of Glasgow - Department of Economics; National Bureau of Economic Research (NBER)

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Isaac Kleshchelski

Northwestern University

Sergio T. Rebelo

Northwestern University - Kellogg School of Management; Centre for Economic Policy Research (CEPR); University of Rochester - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2006

Abstract

Currencies that are at a forward premium tend to depreciate. This 'forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. In practice bid-ask spreads are an increasing function of order size. In addition, there is price pressure, i.e. exchange rates are an increasing function of net order flow. Together these frictions greatly reduce the profitability of currency speculation strategies. In fact, the marginal Sharpe ratio associated with currency speculation can be zero even though the average Sharpe ratio is positive.

Suggested Citation

Burnside, A. Craig and Eichenbaum, Martin and Kleshchelski, Isaac and Rebelo, Sergio T., The Returns to Currency Speculation (August 2006). NBER Working Paper No. w12489. Available at SSRN: https://ssrn.com/abstract=927212

Craig Burnside (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
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University of Glasgow - Department of Economics

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Glasgow, Scotland G12 8RT
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National Bureau of Economic Research (NBER)

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Martin Eichenbaum

Northwestern University ( email )

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847-491-8232 (Phone)
847-491-7001 (Fax)

National Bureau of Economic Research (NBER)

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Isaac Kleshchelski

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Sergio Tavares Rebelo

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Leverone Hall
Evanston, IL 60208
United States
847-467-2329 (Phone)
847-491-5719 (Fax)

Centre for Economic Policy Research (CEPR)

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University of Rochester - Department of Economics ( email )

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Rochester, NY 14627
United States
585-275-5252 (Phone)
585-256-2309 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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