The Evidence and Impact of Financial Globalization

Chapter 17

Carry Trade

Ò. Jordà

University of California Davis, Davis, CA, USA

Outline

Introduction

Designing Carry Trade Strategies

A Trading Laboratory for the Carry Trade

The Trader’s Decision Problem

Adjusting for Returns: KS*, AUC*, and Gain–Loss Ratio

Are Carry Trade Returns Compensation for Risk?

Conclusion

Glossary

Further Reading

Introduction

One of the most basic principles of finance states that a zero-cost investment should have zero expected return – in the alternative, there would be an arbitrage opportunity. Frictions and compensation for risk may alter the specifics but not the core of this principle: you should not get something for nothing. The carry trade is an example of a zero-cost investment where the speculator borrows in ...