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The Currency Carry Trade: Selection Skill or Behavioral Bias

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  • Ian Hudson

Abstract

Many attempts have been undertaken to solve the forward premium puzzle with little to no success. The global currency market is considered the most information efficient and transparent of all financial markets since it demonstrates a balance between over and under-reaction to information with remarkable consistency. The Efficient Market Hypothesis espouses investors cannot systematically outperform a benchmark since all investors have access to the same information. Therefore, the expected long-term rate of return for currencies is essentially zero. The Arbitrage Pricing Theory asserts investment returns are random. As such, traders cannot avail themselves of mispriced currencies. The assertion of Uncovered Interest Rate Parity is that bi-national interest rate variance is equal to the expected differential in exchange rates. This paper asks the following questions: does alpha persistence exist in currency carry trade funds or are its excess returns merely a collection of behavioral biases?

Suggested Citation

  • Ian Hudson, 2016. "The Currency Carry Trade: Selection Skill or Behavioral Bias," International Business Research, Canadian Center of Science and Education, vol. 9(9), pages 176-185, September.
    • Handle: RePEc:ibn:ibrjnl:v:9:y:2016:i:9:p:176-185
    as

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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    carry trade; alpha; forward rate bias; behavioral bias; arbitrage pricing theory; uncovered interest rate parity; efficient market hypothesis; forward premium puzzle; behavioral finance;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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