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Carry trades and monetary conditions

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  • Falconio, Andrea

Abstract

This paper investigates the relation between monetary conditions and the excess returns arising from currency carry trades. The results indicate that carry trade average return, Sharpe ratio and downside risk differ substantially across monetary conditions before the onset of the financial crisis in 2008. Specifically, expansive policy shifts in the US result in a decrease in inter-national risk aversion, which in turn leads to a compression in currency risk premia and higher carry trade returns. By contrast, Fed monetary policy is not able to affect international risk aversion and carry trade returns during the crisis and Zero Lower Bound (ZLB) period, when the economic recession reduced the propensity of investors to take on risk exposures. JEL Classification: F31, G15, E52

Suggested Citation

  • Falconio, Andrea, 2016. "Carry trades and monetary conditions," Working Paper Series 1968, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20161968
    Note: 2171716
    as

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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1968.en.pdf
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    References listed on IDEAS

    as
    1. Koenker,Roger, 2005. "Quantile Regression," Cambridge Books, Cambridge University Press, number 9780521845731.
    2. Loriano Mancini & Angelo Ranaldo & Jan Wrampelmeyer, 2013. "Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums," Journal of Finance, American Finance Association, vol. 68(5), pages 1805-1841, October.
    3. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, vol. 97(1), pages 89-117, March.
    4. Ledoit, Oliver & Wolf, Michael, 2008. "Robust performance hypothesis testing with the Sharpe ratio," Journal of Empirical Finance, Elsevier, vol. 15(5), pages 850-859, December.
    5. Jensen, Gerald R. & Moorman, Theodore, 2010. "Inter-temporal variation in the illiquidity premium," Journal of Financial Economics, Elsevier, vol. 98(2), pages 338-358, November.
    6. Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2008. "Arbitrage in the foreign exchange market: Turning on the microscope," Journal of International Economics, Elsevier, vol. 76(2), pages 237-253, December.
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    Cited by:

    1. Kerstin Bernoth & Helmut Herwartz & Lasse Trienens, 2023. "The Impacts of Global Risk and US Monetary Policy on US Dollar Exchange Rates and Excess Currency Returns," Discussion Papers of DIW Berlin 2037, DIW Berlin, German Institute for Economic Research.

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    More about this item

    Keywords

    carry trade; international risk aversion; monetary conditions;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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