Do Peso Problems Explain the Returns to the Carry Trade?

A. Craig Burnside, Martin S. Eichenbaum, Isaac Kleshchelski, Sergio Rebelo

NBER Working Paper No. 14054
Issued in June 2008
NBER Program(s):   AP   EFG   IFM   ME

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 which 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.

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Published: Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2011. "Do Peso Problems Explain the Returns to the Carry Trade?," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 853-891.

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This paper was revised on December 5, 2011

Acknowledgments

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