Do Peso Problems Explain the Returns to the Carry Trade

By Craig Burnside, Martin Eichenbaum, Isaac Kleshchelski, Sergio Rebelo. 2011

580 citations recorded by the source corpus.

We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/ea70ae496c1798752ad246f2dc2e91651f40238a

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Citations in the corpus

On financial risk and the safe haven characteristics of Swiss franc exchange rates (2015, result): “This finding is in line with the view that peso problems or crash risk explain exchange rate dynamics as proposed by Burnside et al. (2011) and Farhi et al. (2009). The expectation of a small probability, but potentially catastrophic, event in the euro area could be an explanation of the Swiss franc”
Properties of Foreign Exchange Risk Premiums (2012, background): “…processing, e.g. Bacchetta and van Wincoop (2009); differences in developed versus emerging markets, e.g. Bansal and Dahlquist (2000) and Frankel and Poonawala (2010); and the profitability and economic value of currency speculation, e.g. Burnside et al. (2010), and Della Corte et al. (2009).”
Carry Trade and Momentum in Currency Markets (2011, methodology): “It is the same as the equally-weighted strategy studied by Burnside et al. (2011).”
The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk (2007, methodology): “The same sample of currencies is used by Burnside et al. (2011) for the period 1976–2009, and similar samples are used by Lustig, Roussanov, and Verdelhan (forthcoming) and Lukas Menkhoff et al.”
Investor Overconfidence and the Forward Premium Puzzle (2011, unknown): “Burnside et al. (2010), however, provide new evidence suggesting that conventional models of time-varying exchange rate risk premia do not explain the forward premium puzzle.”
Carry Trades and Global Foreign Exchange Volatility (2012, unknown): “This is consistent with Burnside et al. (2011), who ﬁnd in a more detailed analysis that standard business cycle risk factors are unable to account for returns to carry trades.”