An Empirical Investigation into the Reversal of the Carry Trade

The carry trade, where profits can be made in currency markets using price information alone, has been a persistent anomaly in financial markets since the collapse of Bretton Woods. The paper investigates the reversal of the carry trade since the Global Financial Crisis, aims to contribute towards a better understanding of currency markets, and to understand how the carry trade reacts to changes in the short-term policy rate. The results suggest that the carry trade is not a risk-premium, but is driven by momentum. The reversal of the carry trade, and changes in reaction to short-term policy rates, are consistent with a change in the effectiveness of monetary policy since the Global Financial Crisis, where central banks intervene directly to provide domestic liquidity: a liquidity put.