DP7345 The Time-Varying Systematic Risk of Carry Trade Strategies

Author(s):	Charlotte Christiansen, Angelo Ranaldo, Paul Söderlind
Publication Date:	June 2009
Keyword(s):	carry trade, factor model, smooth transition regression, time-varying betas
JEL(s):	F31, G11, G15
Programme Areas:	International Macroeconomics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=7345

This paper suggests a factor model for carry trade strategies where the regression coefficients are allowed to depend on market volatility and liquidity. Empirical results on daily data from 1995 to 2008 show that a typical carry trade strategy has much higher exposure to the stock market and also more mean reversion in volatile periods - and that FX market volatility is a priced risk factor. The findings are robust to various extensions, including using more currencies and other proxies for volatility and liquidity (VIX, TED and a bid-ask spread).