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Risk-premia, Carry-trade Dynamics, and Economic Value of Currency Speculation

Publication: Research - peer-reviewJournal article

In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited ‘forward bias puzzle’ originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia, however, the economic value generated by bilateral carry-trades is limited.

Publication information

Original languageEnglish
JournalJournal of International Money and Finance
Volume31
Issue number5
Pages (from-to)1195–1219
ISSN0261-5606
DOIs
StatePublished - 2012

ID: 38123930