Munich Personal RePEc Archive

Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation

Wagner, Christian (2009): Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation.

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Abstract

In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited `forward bias puzzle' originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia and generates economic value when applied in multi-currency portfolios.

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