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

Research output: Contribution to journalJournal articleResearchpeer-review

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.
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.
LanguageEnglish
JournalJournal of International Money and Finance
Volume31
Issue number5
Pages1195–1219
ISSN0261-5606
DOIs
StatePublished - 2012

Keywords

    Cite this

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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.",
    keywords = "Exchange rates, Uncovered interest parity, Risk-premia, Carry-trade, Economic value",
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    Risk-premia, Carry-trade Dynamics, and Economic Value of Currency Speculation. / Wagner, Christian.

    In: Journal of International Money and Finance, Vol. 31, No. 5, 2012, p. 1195–1219.

    Research output: Contribution to journalJournal articleResearchpeer-review

    TY - JOUR

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    AB - 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.

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    KW - Uncovered interest parity

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    DO - 10.1016/j.jimonfin.2012.01.013

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