Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation

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Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation

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Title: Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation
Author: Wagner, Christian
Abstract: In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited `forward bias puzzle' originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia and generates economic value when applied in multi-currency portfolios.
URI: http://hdl.handle.net/10398/9099
Date: 2015-01-26
Notes: NOTICE: this is the author’s version of a work that was accepted for publication in Journal of International Money and Finance. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of International Money and Finance, Vol31, Issue5, September 2012. DOI:10.1016/j.jimonfin.2012.01.013

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