Do Peso Problems Explain the Returns to the Carry Trade?

Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo

doi:10.1093/rfs/hhq138

Do Peso Problems Explain the Returns to the Carry Trade?

Craig Burnside¹; Martin Eichenbaum²; Isaac Kleshchelski³; Sergio Rebelo⁴

¹ Duke University · ² Federal Reserve Bank of Chicago · ³ Washington University in St. Louis · ⁴ Center for Economic and Policy Research

Review of Financial Studies 2011 open access

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 that are on average large and uncorrelated with traditional risk factors. We argue that these payoffs reflect a peso problem. The underlying peso event features high values of the stochastic discount factor rather than very large negative payoffs.

DOI: 10.1093/rfs/hhq138
Volume: 24 (3)
Pages: 853-891
Language: en
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