Finance Papers

Document Type

Journal Article

Date of this Version

3-2014

Publication Source

Journal of Financial Economics

Volume

111

Issue

3

Start Page

527

Last Page

553

DOI

10.1016/j.jfineco.2013.12.005

Abstract

We describe a novel currency investment strategy, the ‘dollar carry trade,’ which delivers large excess returns, uncorrelated with the returns on well-known carry trade strategies. Using a no-arbitrage model of exchange rates we show that these excess returns compensate U.S. investors for taking on aggregate risk by shorting the dollar in bad times, when the U.S. price of risk is high. The countercyclical variation in risk premia leads to strong return predictability: the average forward discount and U.S. industrial production growth rates forecast up to 25% of the dollar return variation at the one-year horizon. The estimated model implies that the variation in the exposure of U.S. investors to worldwide risk is the key driver of predictability.

Copyright/Permission Statement

© 2014. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/.

Embargo Date

4-2018

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Date Posted: 27 November 2017

This document has been peer reviewed.