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Carry Trade Fundamentals and the Financial Crisis 2007-2010

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Author Info
Vistesen, Claus

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Abstract

This paper takes the form of an event study surrounding the current financial crisis. It proposes a theoretical relationship which can be used to model traditional carry trade crosses on a daily return basis as a negative function of equity returns and a positive function of market volatility. In order to test this theory, an Arbitrage Pricing Theory framework is adopted which is used to estimate the factor betas of carry trade crosses with respect to equity returns and market volatility. It is shown how the variation in the currency crosses explained by the functional relationship as well as the estimated factor betas have increased significantly in relation to the financial crisis. The results indicate that low yielding currencies (the JPY and CHF) can be successfully modeled as a negative function of equity returns and a positive function of volatility in the market. The results furthermore underpin studies that have shown how carry trading activity is highly sensitive towards sudden sparks of volatility and risk aversion, and thus how carry trade fundamentals are time varying.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9952.

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Date of creation: 09 Jul 2009
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Handle: RePEc:pra:mprapa:9952

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Related research
Keywords: International finance; carry trading; financial crisis; currencies;

Other versions of this item:

Find related papers by JEL classification:
F3 - International Economics - - International Finance
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
F31 - International Economics - - International Finance - - - Foreign Exchange

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Christiansen, Charlotte & Ranaldo, Angelo & Söderlind, Paul, 2009. "The Time-Varying Systematic Risk of Carry Trade Strategies," CEPR Discussion Papers 7345, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-38, July. [Downloadable!] (restricted)
  4. Emmanuel Farhi & Xavier Gabaix, 2008. "Rare Disasters and Exchange Rates," NBER Working Papers 13805, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Aidan Corcoran, 2009. "The Determinants of Carry Trade Risk Premia," The Institute for International Integration Studies Discussion Paper Series iiisdp287, IIIS. [Downloadable!]
  6. Joseph E. Gagnon & Alain P. Chaboud, 2007. "What can the data tell us about carry trades in Japanese yen?," International Finance Discussion Papers 899, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  7. Daniel Kohler, 2007. "Carry Trades: Betting Against Safe Haven," University of St. Gallen Department of Economics working paper series 2007 2007-12, Department of Economics, University of St. Gallen. [Downloadable!]
  8. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December. [Downloadable!] (restricted)
  9. Marie Brière & Bastien Drut, 2009. "The Revenge of Purchasing Power Parity on Carry Trades during Crises," Working Papers CEB 09-013.RS, Université Libre de Bruxelles, Solvay Brussels School of Economics and Management, Centre Emile Bernheim (CEB). [Downloadable!]
  10. Alexander, Gordon J. & Chervany, Norman L., 1980. "On the Estimation and Stability of Beta," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(01), pages 123-137, March. [Downloadable!]
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This page was last updated on 2009-11-9.

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