An Empirical Investigation into the Reversal of the Carry Trade

Date

2017-07-11

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Conference

Peer reviewed

Yes

Abstract

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.

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Keywords

Global financial crisis; carry trade; liquidity

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Research Institute

Finance and Banking Research Group (FiBRe)