NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Returns to Currency Speculation

Craig Burnside, Martin Eichenbaum, Isaac Kleshchelski, Sergio Rebelo

NBER Working Paper No. 12489
Issued in August 2006
NBER Program(s):   EFG   IFM   AP

Currencies that are at a forward premium tend to depreciate. This 'forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. In practice bid-ask spreads are an increasing function of order size. In addition, there is price pressure, i.e. exchange rates are an increasing function of net order flow. Together these frictions greatly reduce the profitability of currency speculation strategies. In fact, the marginal Sharpe ratio associated with currency speculation can be zero even though the average Sharpe ratio is positive.

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This paper was revised on January 29, 2007

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Document Object Identifier (DOI): 10.3386/w12489

Published: Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2007. "The Returns to Currency Speculation in Emerging Markets," American Economic Review, American Economic Association, vol. 97(2), pages 333-338, May.

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