Brunnermeier Nagel Pedersen 2008
“Carry Trades and Currency Crashes” by Markus K. Brunnermeier, Stefan Nagel and Lasse Heje Pedersen (NBER Working Paper 14473; NBER Macroeconomics Annual 2008, Vol. 23) documents that FX Currency Carry Trade returns in high-interest-rate “investment” currencies are negatively skewed: exchange rates rise gradually but crash sharply, because carry positions unwind suddenly when risk appetite and funding liquidity decline. The authors show that speculator net positions (CFTC data) increase crash risk, that a higher VIX coincides with carry unwinds and losses, and that controlling for funding-liquidity proxies helps explain the uncovered-interest-parity / forward-premium puzzle. It appears in this vault as the canonical evidence that FX markets — including the EUR USD Currency Pair — have a sharp, rare crash regime that any hidden-Markov or regime-switching model must contend with, and that a model fitted on a long calm sample will tend to under-weight.
Connections
- Currency Carry Trade — defines, carry-trade crash-risk and funding-liquidity model, source: https://www.nber.org/papers/w14473
- EUR USD Currency Pair — detects_regime, negatively-skewed crash regime in FX investment currencies, source: https://www.nber.org/papers/w14473
- Non-Stationarity — relates, rare crash regime under-sampled in calm-period FX data, source: https://www.nber.org/papers/w14473