NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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 investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates.

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This paper was revised on January 29, 2010

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