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Good Carry, Bad Carry

Last Updated on 10 February, 2024 by Rejaul Karim

In the research paper titled “Good Carry, Bad Carry” authored by Geert Bekaert and George Panayotov, the distinction between “good” and “bad” carry trades constructed from G-10 currencies is explored.

The paper delves into the differences in Sharpe ratios and return skewness, revealing that the good trades exhibit higher Sharpe ratios and sometimes positive return skewness, while the bad trades have lower Sharpe ratios and negative return skewness.

Surprisingly, the good trades do not involve the most typical carry currencies like the Australian dollar and Japanese yen. This paper challenges conventional explanations and significantly alters our understanding of currency carry trade returns.

Abstract Of Paper

We distinguish between ”good” and ”bad” carry trades constructed from G-10 currencies. The good trades exhibit higher Sharpe ratios and sometimes positive return skewness, in contrast to the bad trades that have both substantially lower Sharpe ratios and highly negative return skewness. Surprisingly, good trades do not involve the most typical carry currencies like the Australian dollar and Japanese yen. The distinction between good and bad carry trades significantly alters our understanding of currency carry trade returns, and invalidates, for example, explanations invoking return skewness and crash risk.

Original paper – Download PDF

Here you can download the PDF and original paper of Good Carry, Bad Carry.

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Author

Geert Bekaert
Columbia University – Columbia Business School, Finance

George Panayotov
Hong Kong University of Science & Technology (HKUST)

Conclusion

The research paper has significantly altered the traditional understanding of currency carry trade returns. By distinguishing between “good” and “bad” carry trades, the paper has shed light on the factors that contribute to higher Sharpe ratios and positive return skewness.

This distinction holds the potential to revolutionize the approach to currency carry trades and invalidates previous explanations involving return skewness and crash risk.

The comprehensive analysis presented in this paper provides valuable insights that can have significant implications for the field of finance and currency risk factors.

Related Reading:

Pricing Risks across Currency Denominations

Cross-Asset Return Predictability: Carry Trades, Stocks and Commodities

FAQ

Q1: What is the main distinction made in the research paper “Good Carry, Bad Carry”?

A1: The paper distinguishes between “good” and “bad” carry trades constructed from G-10 currencies. This differentiation is based on the analysis of Sharpe ratios and return skewness. “Good” carry trades are characterized by higher Sharpe ratios and sometimes positive return skewness, while “bad” carry trades exhibit substantially lower Sharpe ratios and highly negative return skewness.

Q2: What surprising finding challenges conventional explanations in the paper?

A2: One surprising finding is that the “good” carry trades, which have higher Sharpe ratios and positive return skewness, do not necessarily involve the most typical carry currencies like the Australian dollar and Japanese yen. This challenges conventional explanations and adds a new dimension to the understanding of currency carry trade returns.

Q3: How does the distinction between “good” and “bad” carry trades impact our understanding of currency carry trade returns?

A3: The distinction significantly alters the traditional understanding of currency carry trade returns. It brings to light the factors that contribute to higher Sharpe ratios and positive return skewness, challenging previous explanations related to return skewness and crash risk. This new perspective presented in the paper has the potential to reshape the approach to currency carry trades and provides valuable insights for the field of finance and currency risk factors.

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