TY  - JOUR
AU  - Burnside,Craig
AU  - Eichenbaum,Martin
AU  - Kleshchelski,Isaac
AU  - Rebelo,Sergio
TI  - The Returns to Currency Speculation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12489
PY  - 2006
Y2  - August 2006
UR  - http://www.nber.org/papers/w12489
L1  - http://www.nber.org/papers/w12489.pdf
N1  - Author contact info:
Craig Burnside
Department of Economics
Duke University
213 Social Sciences Building
Durham, NC 27708-0097
Tel: 919/660-1808
Fax: 919/684-8974
E-Mail: craig.burnside@duke.edu

Martin S. Eichenbaum
Department of Economics
Northwestern University
2003 Sheridan Road
Evanston, IL  60208
Tel: 847/491-8232
Fax: 847/491-7001
E-Mail: eich@northwestern.edu

Isaac Kleshchelski
Olin Business School
Washington University in St. Louis
1 Brookings Drive
St. Louis, MO 63130-4899
E-Mail: KLESHCHELSKI@WUSTL.EDU

Sergio Rebelo
Northwestern University
Kellogg School of Management
Department of Finance
Leverone Hall
Evanston, IL  60208-2001
Tel: 847/467-2329
Fax: 847/491-5719
E-Mail: s-rebelo@northwestern.edu
AB  - 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.
ER  -