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Conditionally-hedged currency carry trades

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  • Choi, Jin Ho
  • Suh, Sangwon

Abstract

In this study, we show that currency option prices possess predictive powers on future currency carry trade crashes. We then propose a new currency carry trade strategy that hedges carry trade crash risks only when crashes are predicted. We find that the new conditionally-hedged strategy not only hedges crash risks but also offers a significant increase in profit, compared to the conventional currency carry trade strategy during the hedging periods. The superiority of the new conditionally-hedged carry trade relative to the conventional carry trade is robust to various specification changes. Our results oppose the argument that excess returns from a carry trade are compensation for crash risk exposures.

Suggested Citation

  • Choi, Jin Ho & Suh, Sangwon, 2022. "Conditionally-hedged currency carry trades," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 79(C).
    • Handle: RePEc:eee:intfin:v:79:y:2022:i:c:s1042443122000737
    DOI: 10.1016/j.intfin.2022.101591
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    Cited by:

    1. Kazuki Amagai & Tomoya Suzuki, 2023. "Long-Term Modeling of Financial Machine Learning for Active Portfolio Management," Papers 2301.12346, arXiv.org.

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    More about this item

    Keywords

    Currency carry trade; Crash risk; Predictability; Hedging;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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