Carry Trades and Global Foreign Exchange Volatility

Menkhoff, Lukas; Sarno, Lucio; Schmeling, Maik; Schrimpf, Andreas

doi:10.1111/j.1540-6261.2012.01728.x

Cited by 773 publications

(610 citation statements)

References 68 publications

(128 reference statements)

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“…We can thus conclude that investors' risk aversion clearly plays an important role in the tail behaviour. This conclusion corroborates recent literature regarding the skewness and the kurtosis features characterising the currency carry trade portfolios [5,11,23].…”

Section: Remark 2 (Model Risk and Its Influence On Upside And Downsidsupporting

confidence: 81%

“…Our empirical analysis consists of daily exchange rate data for a set of 34 currency exchange rates relative to the USD, as in [23] We have considered daily settlement prices for each currency exchange rate as well as the daily settlement price for the associated 1 month forward contract. We utilise the same dataset (albeit starting in 1989 rather than 1983 and running up until January 2014) as studied in [20,23] in order to replicate their portfolio returns without tail dependence risk adjustments. Due to differing market closing days, e.g.…”

Section: Exchange Rate Multivariate Data Description and Currency Pormentioning

confidence: 99%

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Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence

Ames

Peters

Bagnarosa

et al. 2015

Innovations in Quantitative Risk Management

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Currency carry trade is the investment strategy that involves selling low interest rate currencies in order to purchase higher interest rate currencies, thus profiting from the interest rate differentials. This is a well known financial puzzle to explain, since assuming foreign exchange risk is uninhibited and the markets have rational risk-neutral investors, then one would not expect profits from such strategies. That is, according to uncovered interest rate parity (UIP), changes in the related exchange rates should offset the potential to profit from such interest rate differentials. However, it has been shown empirically, that investors can earn profits on average by borrowing in a country with a lower interest rate, exchanging for foreign currency, and investing in a foreign country with a higher interest rate, whilst allowing for any losses from exchanging back to their domestic currency at maturity. This paper explores the financial risk that trading strategies seeking to exploit a violation of the UIP condition are exposed to with respect to multivariate tail dependence present in both the funding and investment currency baskets. It will outline in what contexts these portfolio risk exposures will benefit accumulated portfolio returns and under what conditions such tail exposures will reduce portfolio returns.

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Section: Remark 2 (Model Risk and Its Influence On Upside And Downsidsupporting

confidence: 81%

Section: Exchange Rate Multivariate Data Description and Currency Pormentioning

confidence: 99%

Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence

Ames

Peters

Bagnarosa

et al. 2015

Innovations in Quantitative Risk Management

View full text Add to dashboard Cite

show abstract

“…They relate these factors to global equity market volatility. In a similar way, Menkhoff et al (2012) found that global foreign exchange volatility risk accounts for the highest explanation of cross-sectional excess returns of carry trade portfolios and that liquidity risk also play a role in the explanation of their foreign exchange expected returns. By constructing a measure of FX global liquidity, Banti et al (2012) show that there is a link between liquidity across currencies and that liquidity risk is priced in the cross section of currency returns.…”

Section: Identification Of the Common Factorsmentioning

confidence: 67%

Common factors and the exchange rate: results from the Brazilian case

Felício¹,

Júnior²

2014

Rev. Bras. Econ.

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“…The latter is relevant in cross sectional analysis as profits from trading strategies typically depend on their risk, which may be different for several forecasters. 5 Sharpe ratios can also be linked to other studies on exchange rate models (Jordà and Taylor, 2009;Rime, Sarno, and Sojli, 2010) or carry trade strategies (Burnside, Eichenbaum, Kleshchelski, and Rebelo, 2010;Menkhoff, Sarno, Schmeling, and Schrimpf, 2011).…”

Section: Forecasting Performancementioning

confidence: 99%

Individual Exchange Rate Forecasts and Expected Fundamentals

2011

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Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW.Download this ZEW Discussion Paper from our ftp server:http://ftp.zew.de/pub/zew-docs/dp/dp11062.pdf Non-technical SummaryExchange rates are one of the most important prices in open economies. Despite their great importance for many enterprises, surprisingly little is known about the economic factors influencing the ups and downs of exchange rates at intermediate horizons. Although several theoretical macroeconomic models do identify potential determinants of exchange rates, empirical studies since the mid-1980s have found that these models do not make more accurate medium-term forecasts than random forecasts. This empirical finding has led to the conclusion that exchange rates and fundamentals are unrelated in the medium term. However, the complexity of currency markets (with heterogeneous market participants or time-variant influencing factors) could conceal a potential relation between economic fundamentals and exchange rates.The present study takes an indirect approach to investigating whether exchange rates are formed based on fundamentals. The defining idea behind our study is to analyze individual forecasts without making assumptions regarding the forecaster's macroeconomic models. Instead, we judge individual forecasts by their forecast ability only. We assume that good exchange rate forecasts are generally based on better information, and analyze whether this information is macroeconomic. To this end, we take a look at the forecast ability of individual forecasts for the USD/EUR exchange rate in conjunction with the forecast ability of associated short-term interest rate forecasts.We view the significant, positive relationship between good exchange rate forecasts (on a one-month horizon) and good interest rate forecast as evidence that exchange rate forecasts benefit from a better interpretation of the macroeconomic reality. This requires a fundamental linkage between exchange rates and macroeconomic variables.If this linkage exists, it should vary in its importance across different market phases. Our further analyses indeed indicate that a correlation between exchange rates and interest rates is especially important when there is an obvious fundamental misalignment between the respective countries. This is the case when there is a great difference between exchange rates and their fundamental values (based on purchasing power parity), when interest rate differences between the two currencies are large, and when exchange rates do not exhibit a strong tren...

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Carry Trades and Global Foreign Exchange Volatility

Cited by 773 publications

References 68 publications

Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence

Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence

Common factors and the exchange rate: results from the Brazilian case

Individual Exchange Rate Forecasts and Expected Fundamentals

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