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Carry Trades and Currency Crashes

Markus Brunnermeier, Stefan Nagel and Lasse Pedersen

Working Papers from Princeton University. Economics Department.

Abstract: This paper documents that carry traders are subject to crash risk: i.e. exchange rate movements between high-interest-rate and low-interest-rate currencies are negatively skewed. We argue that this negative skewness is due to sudden unwinding of carry trades, which tend to occur in periods in which risk appetite and funding liquidity decrease. Funding liquidity measures predict exchange rate movements, and controlling for liquidity helps explain the uncovered interest-rate puzzle. Carry-trade losses reduce future crash risk, but increase the price of crash risk. We also document excess comovement among currencies with similar interest rate. Our findings are consistent with a model in which carry traders are subject to funding liquidity constraints.

Keywords: Carry Trade; Crash Risk (search for similar items in EconPapers)
JEL-codes: E44 F3 F31 G12 (search for similar items in EconPapers)
Date: 2008-11
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (53)

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https://www.nber.org/system/files/working_papers/w14473/w14473.pdf

Related works:
Chapter: Carry Trades and Currency Crashes (2009) Downloads
Working Paper: Carry Trades and Currency Crashes (2008) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:pri:econom:2008-1

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