Currency Carry Trade
The currency carry trade sells low-interest-rate “funding” currencies and invests in high-interest-rate “investment” currencies, earning the interest-rate differential. It has a positive average return — a premium for providing liquidity — but its returns are negatively skewed in investment currencies: exchange rates “go up by the stairs and down by the elevator”, because carry positions unwind suddenly when risk appetite and funding liquidity fall, an effect that intensifies when global volatility (VIX) rises. The carry trade appears in this vault because it gives FX markets a pronounced two-state regime structure — calm accumulation versus crash unwind — directly relevant to hidden-Markov and regime-switching models, while also being a textbook case of the rare-crash-state problem that a Markov model fitted on a long calm sample will systematically under-weight.
Connections
- EUR USD Currency Pair — relates, FX rollover/swap cost is the carry; FX carry-unwind regimes, source: https://www.nber.org/papers/w14473
- Brunnermeier Nagel Pedersen 2008 — detects_regime, carry-trade crash-risk and funding-liquidity model, source: https://www.nber.org/papers/w14473
- Non-Stationarity — relates, calm-period samples under-weight the rare crash-unwind regime, source: https://www.nber.org/papers/w14473