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Off the Golden Fetters: Examining Interwar Carry Trade and Momentum

Last Updated on 10 February, 2024 by Rejaul Karim

In the research paper titled “Off the Golden Fetters: Examining Interwar Carry Trade and Momentum” authored by Jason Cen and Ian W. Marsh, an extensive examination of the properties of carry trade and momentum returns during the interwar period, 1921:1-1936:12, is presented.

The study reveals that currencies with higher interest rates outperformed currencies with lower interest rates by approximately 7% per annum, aligning with estimates from modern samples.
Furthermore, the momentum strategy of being long past winner and short past loser currencies resulted in an average annual excess return of around 7% in the interwar sample, surpassing its modern counterparts.

The findings challenge prevalent explanations for the returns to the carry trade and momentum, undermining the rare disaster-based explanation, and instead establishing the impact of global FX volatility risk on the carry trade return.

Abstract Of Paper

We study the properties of carry trade and momentum returns in the interwar period, 1921:1-1936:12. We find that currencies with higher interest rates outperform currencies with lower interest rates by about 7% per annum, consistent with estimates from modern samples, while a momentum strategy that is long past winner and short past loser currencies rewards an average annual excess return of around 7% in the interwar sample, larger than its modern counterparts. On the grounds that the interwar period represents rare events better than modern samples, we provide evidence unfavorable to the rare disaster based explanation for the returns to the carry trade and momentum. Global FX volatility risk, however, turns out to account for the carry trade return in the interwar sample as well as in modern samples.

Original paper – Download PDF

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Author

Jason Cen
University of Exeter Business School

Ian W. Marsh
City University London – The Business School

Conclusion

The research paper has illuminated the nuanced dynamics of carry trade and momentum returns during the interwar period, offering valuable insights and implications for understanding risk premia and rare disasters in the realm of foreign exchange.

The evidence presented not only highlights the robustness of the carry trade and momentum strategy during the interwar era but also challenges conventional interpretations, favoring an explanation grounded in global FX volatility risk.

This re-examination of historical data contributes significantly to our comprehension of interwar financial markets and provides a deeper understanding of the enduring forces shaping currency market dynamics in different historical contexts.

Related Reading:

The Carry Trade: Risks and Drawdowns

The Term Structure of Currency Carry Trade Risk Premia

FAQ

Q1: What are the key findings of the research paper “Off the Golden Fetters: Examining Interwar Carry Trade and Momentum”?

A1: The research paper finds that during the interwar period (1921:1-1936:12), currencies with higher interest rates outperformed currencies with lower interest rates by approximately 7% per annum, aligning with estimates from modern samples. Additionally, the momentum strategy of being long past winner and short past loser currencies resulted in an average annual excess return of around 7% in the interwar sample, surpassing its modern counterparts. The findings challenge prevalent explanations for the returns to the carry trade and momentum, undermining the rare disaster-based explanation and instead establishing the impact of global FX volatility risk on the carry trade return.

Q2: How do the findings challenge prevalent explanations for the returns to carry trade and momentum?

A2: The findings challenge the prevalent rare disaster-based explanation for the returns to carry trade and momentum. The evidence from the interwar period, considered to represent rare events better than modern samples, does not support the rare disaster explanation. Instead, the study establishes that global FX volatility risk accounts for the carry trade return during the interwar sample, as well as in modern samples. This challenges conventional interpretations and provides a different perspective on the factors influencing carry trade and momentum returns.

Q3: What are the implications of the research findings for understanding risk premia and historical currency market dynamics?

A3: The research findings have implications for understanding risk premia and historical currency market dynamics. The study contributes to a deeper understanding of the enduring forces shaping currency market dynamics during the interwar period. The evidence supports the robustness of the carry trade and momentum strategy during this historical era and suggests that explanations grounded in global FX volatility risk may be more relevant than rare disaster-based explanations. This contributes to the broader discourse on risk factors and historical developments in currency markets.

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