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When Carry Goes Bad: The Magnitude, Causes, and Duration of Currency Carry Unwinds

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  • Michael Melvin
  • Duncan Shand

Abstract

We analyze the worst episodes of currency carry loss in recent decades, including causes, attribution by currency, timing, and duration of carry drawdowns. To explore the determinants of the length of carry losses, we estimate a model of carry drawdown duration. We find evidence that drawdown duration varies systematically with (1) expected return on the carry trade at the onset of the drawdown, (2) financial stress indicators, and (3) the magnitude of deviations from a fundamental value portfolio of the carry-related portfolio holdings. In an out-of-sample test, we show that these determinants can be used to control carry-related losses and improve investment performance.Editor’s note:This article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the authors thanked the reviewers in their acknowledgments. Denis Chaves was one of the reviewers for this article.Submitted 27 October 2015Accepted 17 August 2016 by Stephen Brown

Suggested Citation

  • Michael Melvin & Duncan Shand, 2017. "When Carry Goes Bad: The Magnitude, Causes, and Duration of Currency Carry Unwinds," Financial Analysts Journal, Taylor & Francis Journals, vol. 73(1), pages 121-144, January.
    • Handle: RePEc:taf:ufajxx:v:73:y:2017:i:1:p:121-144
    DOI: 10.2469/faj.v73.n1.4
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    1. Melvin, Michael & Taylor, Mark P., 2009. "The crisis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1317-1330, December.
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    3. Lasse Pedersen, 2009. "When Everyone Runs for the Exit," International Journal of Central Banking, International Journal of Central Banking, vol. 5(4), pages 177-199, December.
    4. Jordà, Òscar & Taylor, Alan M., 2012. "The carry trade and fundamentals: Nothing to fear but FEER itself," Journal of International Economics, Elsevier, vol. 88(1), pages 74-90.
    5. 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.
    6. Momtchil Pojarliev & Richard M. Levich, 2007. "Do Professional Currency Managers Beat the Benchmark?," NBER Working Papers 13714, National Bureau of Economic Research, Inc.
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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