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The Revenge of Purchasing Power Parity on Carry Trades during Crises

Drut, Bastien; Brière, Marie (2009-07), The Revenge of Purchasing Power Parity on Carry Trades during Crises. https://basepub.dauphine.fr/handle/123456789/7743

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RePEc_sol_wpaper_09-013.pdf (183.3Kb)
Type
Document de travail / Working paper
Date
2009-07
Publisher
ULB : Universite Libre de Bruxelles
Series title
CEB Working Paper
Series number
09/013
Published in
Bruxelles
Pages
27
Metadata
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Author(s)
Drut, Bastien
Brière, Marie
Abstract (EN)
Empirical evidence shows that fundamental models have produced disappointing results over the past 20 years while carry trade strategies have performed superbly. But the real picture is much more complex. In fact, the track records of both strategies have varied considerably. This article shows that they have actually alternated between periods of profitability and underperformance. It also shows that when carry trade strategies perform well, fundamental strategies do poorly, and vice versa. Crises appear to play a significant role in the alternation of investment styles on currency markets. In contrast to carry trades, fundamental strategies perform remarkably well in crises. A portfolio that rotates between these two types of strategies, based on a risk aversion indicator such as implied equity volatility, would substantially outperform a pure carry trade strategy and would be robust to crises.
Subjects / Keywords
Carry trades; exchange rates; financial crisis; risk aversion; investment strategy; purchasing power parity; fundamentals model
JEL
G15 - International Financial Markets
G11 - Portfolio Choice; Investment Decisions
F31 - Foreign Exchange

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