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

Christian Wagner

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    Abstract

    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.
    OriginalsprogEngelsk
    TidsskriftJournal of International Money and Finance
    Vol/bind31
    Udgave nummer5
    Sider (fra-til)1195–1219
    Antal sider25
    ISSN0261-5606
    DOI
    StatusUdgivet - sep. 2012

    Emneord

    • Exchange rates
    • Uncovered interest parity
    • Risk-premia
    • Carry-trade
    • Economic value

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