- Title
- Carry Trades and Currency Crashes
- Author(s)
- Markus K. Brunnermeier Markus Brunnermeier (Princeton University)
- Stefan Nagel Stefan Nagel (University of Michigan)
- Lasse H. Pedersen Lasse Pedersen (Copenhagen Business School)
- Abstract
- This paper documents that carry traders are subject to crash risk: i.e. exchange rate movements between high-interest-rate and low-interest-rate currencies are negatively skewed. We argue that this negative skewness is due to sudden unwinding of carry trades, which tend to occur in periods in which risk appetite and funding liquidity decrease. Funding liquidity measures predict exchange rate movements, and controlling for liquidity helps explain the uncovered interest-rate puzzle. Carry-trade losses reduce future crash risk, but increase the price of crash risk. We also document excess comovement among currencies with similar interest rate. Our findings are consistent with a model in which carry traders are subject to funding liquidity constraints.
- Creation Date
- 2008-11
- Section URL ID
- Paper Number
- 2008-1
- URL
- https://www.nber.org/system/files/working_papers/w14473/w14473.pdf
- File Function
- Jel
- E44, F3, F31, G12
- Keyword(s)
- Carry Trade, Crash Risk
- Suppress
- false
- Series
- 13