VoxEU Column International Finance

Getting beyond carry trade: What makes a safe-haven currency?

What makes a safe-haven currency? This column analyses a panel of 52 currencies in advanced and emerging countries over the past 25 years. It finds that safe-haven status is not determined by the interest rate spread, as emphasised in the carry trade literature, but by the net foreign asset position, which is an indicator of country risk and external vulnerability.

We all “know” that some currencies are safe havens in crisis times – take the Japanese yen or the Swiss franc. But do we know why? And does the dollar belong to this list?

There is a well established and fast-growing body of literature showing how low-yield currencies typically appreciate during times of global financial stress and behave as safe havens (Brunnemeier et al. 2008, Lustig et al. 2008, and Menkhoff et al. 2009). This leads to a systematic deviation from the uncovered interest parity; low-interest rate currencies systematically under-perform except in exceptional circumstances such as when global exchange rate volatility is high.

This empirical regularity is not necessarily the same as safe-haven status. The two concepts – deviation from uncovered parity and safe-haven status – overlap only in so far as, and to the extent which, traders pursue carry trade strategies.

In our recently published work (Habib and Stracca 2011), we try to go beyond this literature and search for the "fundamentals" of safe-haven currencies, analysing a panel of 52 currencies (51 bilateral exchange rates) in advanced and emerging countries over the past 25 years. In short, we ask: What makes a safe-haven currency?

The search for fundamentals

We put forward three possible sets of explanations of a safe-haven status.

  • First, a currency may be a safe haven if the country issuing it is itself safe and low-risk. That may be appreciated by nervous investors in times of high risk aversion.
  • Second, we surmise that size and liquidity of a country's financial market may support a safe-haven status, an argument that has been called for during the latest financial crisis. When global risk aversion is high, market liquidity may dry up and most liquid markets may get an additional bonus.
  • Third, we test whether financial openness and more generally financial globalisation is a determinant of a safe-haven status. An ideal safe haven should be a place that is insulated from the global storm when the storm strikes; a difficult feat in times of financial globalisation.

An essential element of our analysis is to appraise whether and which of these possible determinants is a stable and robust predictor of safe haven behaviour. In particular, we test whether, as commonly argued (see Kohler 2010 for instance), the global credit crisis of 2007-09 has indeed different characteristics, in terms of safe-haven currencies compared with previous high global volatility episodes (see Ranaldo and Soderling 2009). Indeed, the stability analysis confirms the perception that the recent behaviour of the dollar has been rather anomalous compared with previous regularities. Contrary to the common belief, which has been strengthened by the appreciation of the dollar during the recent crisis, the dollar is not always a safe-haven currency.

Our results show that are only very few variables entering consistently and robustly as determinants of safe-haven status. Of course, this result is certainly not unexpected given the large literature on the exchange rate disconnect. Explaining exchange rate behaviour is hard, also in this domain. Nonetheless, we do find a number of variables to be statistically significant and reasonably robust, more so for advanced countries and less so for emerging countries.

First of all, focussing on carry trade, we do find that the interest rate spread is consistently associated with a safe-haven status in advanced countries, but not in emerging countries, probably reflecting the low liquidity and high transaction costs that are typically associated to currencies of emerging economies. This confirms the notion that the interest rate differential is not a fundamental driver of safe-haven status, and it depends on carry trade strategies being pursued.

After controlling for carry trade, in the whole sample and for emerging markets, we find that the net foreign asset position, an indicator of external vulnerability, and to a lesser extent the absolute size of the stock market, an indicator of market size and financial development, are robustly associated to a safe-haven status. Nonetheless, even the variables that are statistically significant tend to have a rather small quantitative impact on exchange rate behaviour. It is therefore very difficult to explain the safe-haven status, and this should lead to some caution against over-interpreting exchange rate behaviour during financial stress. We still know precious little about the fundamental drivers of exchange rates.


Overall, our findings put the spotlight on the fact that save haven status is not determined by the interest rate spread, as emphasised in the carry trade literature, but by the net foreign asset position, which is an indicator of country risk and external vulnerability. The role of the interest rate spread stems mainly, in the literature and in reality, from the fact that traders tend to follow carry trade strategies, targeting not all currencies and not always the same currencies.

The views expressed in this column are those of the author and do not necessarily reflect those of the European Central Bank.


Brunnermeier, MK, S Nagel and LH Pedersen (2008), "Carry Trade and Currency Crashes", NBER Working Paper 14473, November.

Habib, MM and L Stracca (2011), "Getting beyond Carry Trade: What Makes a Safe Haven Currency?”, ECB Working Paper 1288, January.

Kohler, M (2010), "Exchange Rates during Financial Crises", in BIS Quarterly Review, March.

Lustig, H, N Roussanov and A Verdelhan (2008), "Common Risk Factors in Currency Markets", NBER Working Paper 14082, June.#

Menkhoff, L, L Sarno, M Schmeling and A Schrimpf (2009), "Carry Trades and Global Foreign Exhange Volatility", mimeo.

Ranaldo, A and P Soderlind (2009), "Safe Haven Currencies", Review of Finance, 14(3):385-407.

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