The Carry Trade: Risks and Drawdowns
Critical Finance Review, forthcoming
62 Pages Posted: 26 Aug 2014 Last revised: 4 Apr 2017
Date Written: March 11, 2016
We find important differences in dollar-based and dollar-neutral G10 carry trades. Dollar-neutral trades have positive average returns, are highly negatively skewed, are correlated with risk factors, and exhibit considerable downside risk. In contrast, a diversified dollar-carry portfolio has a higher average excess return, a higher Sharpe ratio, minimal skewness, is uncorrelated with standard risk-factors, and exhibits no downside risk. Distributions of drawdowns and maximum losses from daily data indicate a role for time-varying autocorrelation in determining negative skewness at longer horizons.
Keywords: currency carry trade, currency risk factors, market efficiency
JEL Classification: F31, G12, G15
Suggested Citation: Suggested Citation