a b s t r a c tWe show that carry trade strategies resemble FX option strategies that sell out of the money puts on high interest rate currencies. Both strategies collect premiums to generate persistent excess returns that unwind sharply when volatility increases. We also show that the widely documented negative slope coefficient in regressions of exchange rate depreciation on forward currency premiums is an artifact of the volatility regime. In high volatility regimes, the so-called Fama regression produces a positive coefficient greater than unity. We finally document the existence of an intuitive co-movement between currency risk premiums and yield curve risk factors.

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We present a robust value-at-risk model that takes into account the possibility of model misspecification. In place of a single prior distribution, we utilize multiple priors in the form of an 'uncertainty set' around the estimated expected returns and covariance matrix, constructed using the information-theoretic notion of Kullback-Leibler divergence. An extension to conditional value-at-risk is also specified.