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15.07.2010

The Revenge of Fundamentals on Carry Trades during Crises

Published 

15 July, 2010

> 10 minutes
15.07.2010
The Revenge of Fundamentals on Carry Trades during Crises
Published 

15 July, 2010

> 10 minutes

Over the past 20 years, FX carry trades have performed superbly while fundamental strategies have produced disappointing results. But the real picture is much more complex, for at least two reasons: carry trading exhibits strong extreme risks, and the track records of both strategies vary considerably over time. In this paper, we show that the carry trade and a fundamental strategy based on purchasing power parity (PPP) have alternated between periods of profitability and underperformance. When carry trade strategies perform well, fundamental strategies do poorly, and vice versa. Crises appear to play a significant role in this alternation. A portfolio that rotates between these two types of strategies, according to a VIX-based risk aversion indicator, would substantially outperform a pure carry trade strategy, with a sharp reduction in extreme risks, and would also be robust to crises.

 

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