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The Carry Trade: Risks and Drawdowns

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  • Daniel, Kent
  • Hodrick, Robert J.
  • Lu, Zhongjin

Abstract

We find important differences in dollar-based and dollar-neutral G10 carry trades. Dollar-neutral trades have positive average returns, are highly negatively skewed, are correlated with risk factors, and exhibit considerable downside risk. In contrast, a diversified dollar-carry portfolio has a higher average excess return, a higher Sharpe ratio, minimal skewness, is unconditionally uncorrelated with standard risk-factors, and exhibits no downside risk. Distributions of drawdowns and maximum losses from daily data indicate a role for timevarying autocorrelation in determining negative skewness at longer horizons.

Suggested Citation

  • Daniel, Kent & Hodrick, Robert J. & Lu, Zhongjin, 2017. "The Carry Trade: Risks and Drawdowns," Critical Finance Review, now publishers, vol. 6(2), pages 211-262, September.
    • Handle: RePEc:now:jnlcfr:104.00000051
    DOI: 10.1561/104.00000051
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    More about this item

    Keywords

    Currency carry trade; Currency risk factors; Market efficiency;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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