Template-type: ReDIF-Paper 1.0
Author-Name: Charlotte Christiansen
Author-Name-First: Charlotte
Author-Name-Last: Christiansen
Author-Person: pch215
Author-Name: Angelo Ranaldo
Author-Name-First: Angelo
Author-Name-Last: Ranaldo
Author-Person: pra161
Author-Name: Paul Söderlind
Author-Name-First: Paul
Author-Name-Last: Söderlind
Author-Person: pso16
Title: The Time-Varying Systematic Risk of Carry Trade Strategies
Abstract: We explain the currency carry trade performance using an asset pricing model in which factor loadings are regime-dependent rather than constant. Empirical results show that a typical carry trade strategy has much higher exposure to the stock market and is mean-reverting in regimes of high FX volatility. The findings are robust to various extensions, including more currencies, longer samples, transaction costs, international stock indices, and other proxies for volatility and liquidity. Our regime-dependent pricing model provides significantly smaller pricing errors than a traditional model. Thus, the carry trade performance is better explained by its time-varying systematic risk that magnifies in volatile markets-suggesting a partial explanation for the Uncovered Interest Rate Parity puzzle.
Length: 42 pages
Creation-Date: 2010
Contact-Email: forschung@snb.ch
File-URL: https://www.snb.ch/en/publications/research/working-papers/2010/working_paper_2010_01
File-Format: text/html
Number: 2010-01
Classification-JEL: F31, G15, G11
Keywords: carry trade, factor model, FX volatility, liquidity, smooth transition regression, time-varying betas
Handle: RePEc:snb:snbwpa:2010-01