Predictability of currency carry trades and asset pricing implicationsGurdip Bakshi and George Panayotov Journal of Financial Economics, 2013, vol. 110, issue 1, 139-163 Abstract: This paper studies the time series predictability of currency carry trades, constructed by selecting currencies to be bought or sold against the US dollar, based on forward discounts. Changes in a commodity index, currency volatility and, to a lesser extent, a measure of liquidity predict in-sample the payoffs of dynamically re-balanced carry trades, as evidenced by individual and joint p-values in monthly predictive regressions at horizons up to six months. Predictability is further supported through out-of-sample metrics, and a predictability-based decision rule produces sizable improvements in the Sharpe ratios and skewness profile of carry trade payoffs. Our evidence also indicates that predictability can be traced to the long legs of the carry trades and their currency components. We test the theoretical restrictions that an asset pricing model, with average currency returns and the mimicking portfolio for the innovations in currency volatility as risk factors, imposes on the coefficients in predictive regressions. Keywords: Currency carry trades; Predictability; Commodity returns; Currency volatility; Liquidity; Predictability-based decision rule; Currency-related risk factors (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:110:y:2013:i:1:p:139-163 DOI: 10.1016/j.jfineco.2013.04.010 Access Statistics for this article Journal of Financial Economics is currently edited by G. William Schwert More articles in Journal of Financial Economics from Elsevier |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.