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Empirical Evidence on the Currency Carry Trade, 1900-2012

Last Updated on 10 February, 2024 by Rejaul Karim

The study titled “Empirical Evidence on the Currency Carry Trade, 1900-2012” by Nikolay Doskov and Laurens Swinkels delves into a comprehensive examination of the risk and return characteristics of the currency carry trade spanning a substantial historical period from 1900 to 2012.

In contrast to the predominant focus on the currency carry trade post the Bretton Woods system collapse, this empirical exploration inquires into the long-term currency carry premium across a diverse set of 20 currencies over more than a century.

The findings reveal the presence of modest Sharpe ratios ranging from 0.2 to 0.4 for carry trading during this extended timeframe, notably lower than the Sharpe ratios reported for more recent sample periods. The study further illuminates occasional substantial losses incurred in carry trading, aligning with risk-based explanations for deviations from uncovered interest parity.

Moreover, the investigation provides valuable insights by highlighting that significant carry trading losses do not consistently align with substantial losses in global equity markets, thereby contributing to an enriched understanding of the underlying rationale and manifestation of excess returns within the domain of the currency carry trade.

Abstract Of Paper

Most of the currency literature investigates the risk and return characteristics of the currency carry trade after the collapse of the Bretton Woods system. In order to gauge the long-term currency carry premium, we extend the sample to 20 currencies over the period 1900 to 2012. We find modest Sharpe ratios in the range of 0.2 to 0.4 for carry trading over this period. This is markedly lower than the Sharpe ratios above 0.6 reported for recent sample periods. We document that carry trading occasionally incurs substantial losses, which fits well with risk-based explanations for deviations from uncovered interest parity. We find that large carry trading losses do not necessarily coincide with large losses in global equity markets. Our results help to better understand the source and nature of excess returns on the carry trade.

Original paper – Download PDF

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Author

Nikolay Doskov
Norges Bank Investment Management (NBIM)

Laurens Swinkels
Erasmus University Rotterdam (EUR); Robeco Asset Management

Conclusion

In conclusion, the study “Empirical Evidence on the Currency Carry Trade, 1900-2012” by Nikolay Doskov and Laurens Swinkels significantly contributes to the ongoing discourse surrounding the risk and return characteristics of the currency carry trade by offering a comprehensive analysis encompassing a remarkable historical expanse.

Through an extensive examination spanning over a century and involving a diverse set of 20 currencies, the study unveils the presence of modest Sharpe ratios ranging from 0.2 to 0.4 for carry trading during this protracted period, underscoring a noteworthy contrast with the higher Sharpe ratios reported for more recent sample periods.

Furthermore, the documentation of occasional substantial losses incurred in carry trading aligns with risk-based explanations for deviations from uncovered interest parity, enriching our understanding of the underlying dynamics.

Notably, the findings also highlight that significant carry trading losses do not consistently align with substantial losses in global equity markets, thereby presenting a nuanced portrayal of the source and nature of excess returns within the domain of the currency carry trade.

This comprehensive investigation adds depth to the understanding of the currency carry trade, providing valuable insights that can inform decision-making and risk management strategies in the realm of international finance.

Related Reading:

Common Risk Factors in Currency Markets

Standard and optimized carry trades

FAQ

Q1: What is the primary focus of the study “Empirical Evidence on the Currency Carry Trade, 1900-2012” by Nikolay Doskov and Laurens Swinkels?

A1: The primary focus of the study is to examine the risk and return characteristics of the currency carry trade over an extensive historical period from 1900 to 2012. In contrast to the prevalent focus on the post-Bretton Woods era, the research provides insights into the long-term currency carry premium across a diverse set of 20 currencies, contributing to a broader understanding of the performance of the carry trade strategy.

Q2: What are the key findings regarding Sharpe ratios in the extended historical sample of the currency carry trade?

A2: The study reveals modest Sharpe ratios in the range of 0.2 to 0.4 for carry trading over the extended period from 1900 to 2012. This is notably lower than the Sharpe ratios reported for more recent sample periods. The findings contribute to the assessment of the risk and return profile of the currency carry trade over a substantial historical span, offering a contrast to the performance observed in more recent times.

Q3: How does the study contribute to the understanding of excess returns within the currency carry trade?

A3: The study enriches the understanding of excess returns within the currency carry trade by documenting occasional substantial losses incurred in carry trading. These findings align with risk-based explanations for deviations from uncovered interest parity. Importantly, the study highlights that significant carry trading losses do not necessarily coincide with large losses in global equity markets, providing nuanced insights into the source and nature of excess returns in the domain of the currency carry trade.

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