03303cam a22002897 4500001000700000003000500007005001700012008004100029100002200070245013300092260006600225490004200291500001900333520083800352520128601190530006102476538007202537538003602609690007002645690006602715700001702781700002102798710004202819830007702861856003802938856003702976w15523NBER20140922113210.0140922s2009 mau||||fs|||| 000 0 eng d1 aClarida, Richard.10aCurrency Carry Trade Regimesh[electronic resource]:bBeyond the Fama Regression /cRichard Clarida, Josh Davis, Niels Pedersen. aCambridge, Mass.bNational Bureau of Economic Researchc2009.1 aNBER working paper seriesvno. w15523 aNovember 2009.3 aWe examine the factors that account for the returns on currency carry trade strategies. Using a dataset of daily returns spanning 18 years for 5 different long - short currency carry portfolios, we first document a robust empirical relationship between carry trade excess returns and exchange rate volatility, both realized and implied. Specifically, we extend and refine the results in Bhansali (2007) by documenting that currency carry trade strategies implemented with forward contracts have payoff and risk characteristics that are similar to those of currency option strategies that sell out of the money puts on high interest rates currencies. Both strategies have the feature of collecting premiums or carry to generate persistent excess returns that unwind sharply resulting in losses when actual and implied volatility rise.3 aWe next also document significant volatility regime sensitivity for Fama regressions estimated over low and high volatility periods. Specifically we find that the well known result that a regression of the realized exchange rate depreciation on the lagged interest rate differential produces a negative slope coefficient (instead of unity as predicted by uncovered interest parity) is an artifact of the volatility regime: when volatility is in the top quartile, the Fama regression produces a positive coefficient that is greater than unity. The third section of the paper documents the existence of an intuitive and significant co-movement between currency risk premium and risk premia in yield curve factors that drive bond yields in the countries that comprise carry trade pairs. We show that yield curve level factors are positively correlated with carry trade excess returns while yield curve slope factors are negatively correlated with carry trade excess returns. Importantly, we show that this correlation is robust to the current crisis and to the inclusion of equity volatility in the model. What distinguishes carry trade returns in the current crisis from non crisis periods is not changed loading on yield curve factors but a much larger loading on the equity factor. aHardcopy version available to institutional subscribers. aSystem requirements: Adobe [Acrobat] Reader required for PDF files. aMode of access: World Wide Web. 7aF3 - International Finance2Journal of Economic Literature class. 7aF31 - Foreign Exchange2Journal of Economic Literature class.1 aDavis, Josh.1 aPedersen, Niels.2 aNational Bureau of Economic Research. 0aWorking Paper Series (National Bureau of Economic Research)vno. w15523.4 uhttp://www.nber.org/papers/w1552341uhttp://dx.doi.org/10.3386/w15523