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).