From carry trades to curvy trades |
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Authors: | Ferdinand Dreher Johannes Gräb Thomas Kostka |
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Institution: | European Central Bank, Frankfurt am Main, Germany |
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Abstract: | Traditional carry trade strategies are based on differences in short-term interest rates, neglecting any other information embedded in yield curves. We derive return distributions of currency portfolios, where the signals to buy and sell currencies are based on summary measures of the yield curve. We find that a strategy based on the relative curvature factor, the curvy trade, yields higher Sharpe ratios and a smaller return skewness than traditional carry strategies. Curvy trades build less upon the typical carry currencies and are hence less susceptible to crash risk. In line with that, standard pricing factors of traditional carry returns fail to explain curvy trade returns. |
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Keywords: | currency carry trades Nelson-Siegel factors yield curve |
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