Do peso problems explain the returns to the carry trade?
By: A. Craig Burnside, Martin S. Eichenbaum, Isaac Kleshchelski, Sergio Rebelo.
Contributors: Eichenbaum, Martin S.; Kleshchelski, Isaac.; Rebelo, Sergio.; National Bureau of Economic Research.
Series: NBER working paper series -- working paper 14054; Working paper series (National Bureau of Economic Research : Online) -- working paper no. 14054.
Publisher: National Bureau of Economic Research
Published: 2008
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Description: "Currencies that are at a forward premium tend to depreciate.  This 'forward- premium puzzle' is an egregious deviation from uncovered interest parity.  We document the properties of the carry trade, a currency speculation strategy that exploits this anomaly.  This strategy consists of borrowing low-interest-rate currencies and lending high-interest-rate currencies.  We first show that the carry trade yields a high Sharpe ratio that is not a compensation for risk.  We then consider a hedged version of the carry trade which protects the investor against large, adverse currency movements.  This strategy, implemented with currency options, yields average payoffs that are statistically indistinguishable from the average payoffs to the standard carry trade.  We argue that this finding implies that the peso problem cannot be a major determinant of the payoff to the carry trade"--National Bureau of Economic Research web site.
Notes: Title from PDF file as viewed on 7/11/2008.

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