Carry trades and economic policy uncertainty: measuring the political dimension of the forward rate bias in emerging countries

This paper investigates the political dimension underlying the phenomenon of carry trade excess returns in emerging economies. Excess carry trade returns are underpinned by an anomaly called the “forward rate bias†. Several authors have argued that this anomaly can be partly explained by country-related risk factors. To investigate this claim, we utilize a new measure of political risk, the Economic Policy Uncertainty Index (EPU). We compare the magnitude of the local and global EPU indices, including country-level and international control variables, in seven emerging countries: Brazil, Chile, Colombia, India, Mexico, Russia and South Korea. Our findings indicate a significant negative relationship between carry trade excess returns and the country's EPU index.