A filtered currency carry trade |
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Affiliation: | School of Economic Mathematics, Southwestern University of Finance and Economics, 555 Liutai Boulevard, Wenjiang, Chengdu 611130, PR China;School of Marxism, School of Business, Key Laboratory of Large Data Processing and Analysis of Electronic Commerce in Henan, Luoyang Normal University, Luoyang 471934, China;Department of Political Economy, National Sun Yat-sen University, No.70 Lien-hai Rd, Kaohsiung 80424, Taiwan, R.O.C |
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Abstract: | In this paper, we document that the predictive capacity of forward discounts on future currency returns not only differs across currencies but also persists. We then propose a new currency carry trade strategy that relies on the differential predictive capacity of forward discounts. We find that the new strategy offers a significant amount of profit improvement over the conventional currency carry trade strategy. We also find that emerging market currencies provide relatively large profit opportunities. While both strategies show decreasing carry trade profits as FX markets get volatile, the relative outperformance of the new carry trade strategy tends to be found in stable periods but disappears in volatile periods. The superiority of the new carry trade relative to the conventional carry trade is robust to various specification changes. |
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Keywords: | Uncovered interest parity Currency carry trade Sorting Filtering signal |
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