Foreign Exchange Risk And The Predictability Of Carry Trade Returns
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Foreign Exchange Risk And The Predictability Of Carry Trade Returns
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Author : Gino Cenedese
language : en
Publisher:
Release Date : 2014
Foreign Exchange Risk And The Predictability Of Carry Trade Returns written by Gino Cenedese and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2014 with categories.
This paper provides an empirical investigation of the time-series predictive ability of foreign exchange risk measures on the return to the carry trade, a popular investment strategy that borrows in low-interest currencies and lends in high-interest currencies. Using quantile regressions, we find that higher market variance is significantly related to large future carry trade losses, which is consistent with the unwinding of the carry trade in times of high volatility. The decomposition of market variance into average variance and average correlation shows that the predictive power of market variance is primarily due to average variance since average correlation is not significantly related to carry trade returns. Finally, a new version of the carry trade that conditions on market variance generates performance gains net of transaction costs.
Foreign Exchange Predictability During The Financial Crisis
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Author : Stanislav Anatolyev
language : en
Publisher:
Release Date : 2017
Foreign Exchange Predictability During The Financial Crisis written by Stanislav Anatolyev and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2017 with categories.
In this paper, we study the effectiveness of carry trade strategies during and after the financial crisis using a flexible approach to modeling currency returns. We decompose the currency returns into multiplicative sign and absolute return components, which exhibit much greater predictability than raw returns. We allow the two components to respond to currency-specific risk factors and use the joint conditional distribution of these components to obtain forecasts of future carry trade returns. Our results suggest that the decomposition model produces higher forecast and directional accuracy than any of the competing models. We show that the forecasting gains translate into economically and statistically significant (risk-adjusted) profitability when trading individual currencies or forming currency portfolios based on the predicted returns from the decomposition model.
Idiosyncratic Consumption Risk And Predictability Of The Carry Trade Premium
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Author : Thomas Nitschka
language : en
Publisher:
Release Date : 2008
Idiosyncratic Consumption Risk And Predictability Of The Carry Trade Premium written by Thomas Nitschka and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2008 with categories.
Volatility Risk Premia And Exchange Rate Predictability
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Author : Pasquale Della Corte
language : en
Publisher:
Release Date : 2013
Volatility Risk Premia And Exchange Rate Predictability written by Pasquale Della Corte and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2013 with Foreign exchange rates categories.
We investigate the predictive information content in foreign exchange volatility risk premia for exchange rate returns. The volatility risk premium is the difference between realized volatility and a model-free measure of expected volatility that is derived from currency options, and reflects the cost of insurance against volatility fluctuations in the underlying currency. We find that a portfolio that sells currencies with high insurance costs and buys currencies with low insurance costs generates sizeable out-of-sample returns and Sharpe ratios. These returns are almost entirely obtained via predictability of spot exchange rates rather than interest rate differentials, and these predictable spot returns are far stronger than those from carry trade and momentum strategies. Canonical risk factors cannot price the returns from this strategy, which can be understood, however, in terms of a simple mechanism with time-varying limits to arbitrage.
The Term Structure Of Currency Carry Trade Risk Premia
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Author : Hanno Lustig
language : en
Publisher:
Release Date : 2013
The Term Structure Of Currency Carry Trade Risk Premia written by Hanno Lustig and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2013 with Economics categories.
We find that average returns to currency carry trades decrease significantly as the maturity of the foreign bonds increases, because investment currencies tend to have small local bond term premia. The downward term structure of carry trade risk premia is informative about the temporal nature of risks that investors face in currency markets. We show that long-maturity currency risk premia only depend on the domestic and foreign permanent components of the pricing kernels, since transitory currency risk is automatically hedged by interest rate risk for long-maturity bonds. Our findings imply that there is more cross-border sharing of permanent than transitory shocks.
Carry Trades And Tail Risk Of Exchange Rates
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Author : Chanaka N. Ganepola
language : en
Publisher:
Release Date : 2018
Carry Trades And Tail Risk Of Exchange Rates written by Chanaka N. Ganepola and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2018 with categories.
Historically, Carry trades have been a success story for most investor and a major source of funds for emerging economies maintaining higher interest rates. Therefore it's a timely topic to investigate the risk embedded in such transactions and to what extent the carry trade returns explain the tail risk. Initially, this research estimates the tail index of all the currencies and formulates a unique inverse function for all the currencies in relation to Power laws, with the idea of estimating the respective Value-at-Risk. This research considers twenty five currencies and replicates them in to five portfolios based on the annualised daily return of a weekly forward contract. Trade was executed assuming a U.S. investor, who goes long in a high return portfolio and short in a low return portfolio. Further, this research examines the impact of carry trade returns on the overall tail risk within the context of foreign exchange and interest rate gain in long and short positions of the trade. The results indicate that tail risk cannot be explained effectively by its returns because of its exponential nature. However, I find that tail risk is mostly influenced by the long position of the carry trade. Furthermore, the return of the foreign exchange component appears to have a better explanation on the tail risk compared to the interest rate return. The Value-at-Risk analysis also suggests that the tail risk of overall strategy is influenced by the tail risk of foreign exchange component embedded in the long position of the trade.
Currency Carry Trades
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Author : Travis J. Berge
language : en
Publisher:
Release Date : 2010
Currency Carry Trades written by Travis J. Berge and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2010 with Carry trades (Foreign exchange) categories.
A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.
Countercyclical Currency Risk Premia
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Author : Hanno Lustig
language : en
Publisher:
Release Date : 2010
Countercyclical Currency Risk Premia written by Hanno Lustig and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2010 with Economics categories.
Currency excess returns are predictable, more than stock returns, and about as much as bond returns. The average forward discount of the dollar against developed market currencies is the best predictor of average foreign currency excess returns earned by U.S. investors on a long position in a large basket of foreign currencies and a short position in the dollar. The predicted excess returns on baskets of foreign currency are strongly counter-cyclical because they inherit the cyclical properties of the average forward discount. This counter-cyclical dollar risk premium compensates U.S. investors for taking on U.S.-specific risk in foreign exchange markets by shorting the dollar. Macroeconomic variables such as the rate of U.S. industrial production growth increase the predictability of average foreign currency excess returns even when controlling for the forward discount -- National Bureau of Economic Research web site.
Carry And Trend Following Returns In The Foreign Exchange Market
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Author :
language : en
Publisher:
Release Date : 2015
Carry And Trend Following Returns In The Foreign Exchange Market written by and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2015 with categories.
Essays On Currency Risks And Returns
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Author : Jingyi Ren
language : en
Publisher:
Release Date : 2019
Essays On Currency Risks And Returns written by Jingyi Ren and has been published by this book supported file pdf, txt, epub, kindle and other format this book has been release on 2019 with categories.
Chapter 11 proposes using foreign exchange rate currency options with different strike prices and maturities to capture both currency risks and expectations, for helping understand currency return dynamics. We show that currency returns, which are notoriously difficult to model empirically, are well-explained by the term structures of forward premia and options-based measures of FX expectations and risk. Although this finding is to be expected, expectations and risk have been largely ignored in empirical exchange-rate modeling. Using daily options data for six major currency pairs, we first show that currency options-implied standard deviation, skewness, and kurtosis consistently improve the explanatory power of quarterly currency returns than a standardized UIP regression. We then show that adding term structure information of options-implied moments further improves the explanatory power. Our results highlight the importance of expectations and risk in explaining currency returns and suggest that this information may be particularly useful during a crisis period. Chapter 2 studies the term structure of currency risk using FX options data, and finds it able to explain the cross-sectional variation of currency excess returns. With the tool of a new FX risk index, "FCX", I look into currency risk term structure and measure its shape by level and slope. I consistently find that for currencies paired by US dollars, the term structure of currency risk is flat at a low level prior to the 2008 crisis, upward-sloping after the crisis and peaks at a high level with a prominently negative slope during the crisis. This work is believed to be new in the currency research field. I then use this information to build trading strategies, earning a profit by longing currencies with the highest level or slope and shorting ones with the lowest level or slope. The profit by sorting slope is significantly high and robust to the 2008 crisis period, with a low correlation to the Carry Trade return, suggesting extra information in risk than the interest rate. Next, I extract global risk factors by level and slope to help understand the currency excess return, a long-lasting puzzle. The global risk factor by level substantially improves the cross-sectional explanatory power in currency excess returns compared to Lustig et al. (2011). Furthermore, I show that there is certain high risk corresponding to a high level and low slope, and high interest rate currency earns returns co-varying negatively to this risk, implying that it is a risky asset and thus requires a high risk premium, which explains the Carry Trade return well. Chapter 32 explores the possible macroeconomic connection in currency markets through the channel of FX risk term structure. There is a consensus in the literature that exchange rates are empirically “disconnected” from fundamentals, but a possible theoretical insight is that macroeconomic volatility shocks induce time-varying risks in the exchange rates. This chapter empirically investigates the connection between macroeconomic fundamentals and time-varying currency risks captured by the FX risk term structure, following the main findings of chapters 1 and 2. This chapter use both a small dataset of directly observable, country-specific key macroeconomic and international variables implied by exchange rate structural modeling and a small number of macroeconomic factors constructed from a large dataset of 126 U.S. macroeconomic series by principal component analysis. We perform a VAR analysis to examine impulse responses of FX risk term structure to the shocks of macroeconomic events and find that production variables can generate a relatively consistent and systematic impact pattern, which suggests potential macroeconomic connection. We also perform a direct single regression, regressing the 126 macroeconomic series of eight different groups on the FX risk term structure and apply the group LASSO technique for variable selection. Variables among both macroeconomic fundamentals and financial series are commonly selected, which suggests that financial markets’ co-movements also exist besides potential macroeconomic connection.