Do Currency Fundamentals Matter for Currency Speculators?

Author/Editor:

Masahiro Nozaki

Publication Date:

February 1, 2010

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

The answer seems affirmative. We compare currency carry trades with an investment strategy based on currency fundamentals: taking a long (short) position in undervalued (overvalued) currencies. Carry trades have high risk-adjusted returns, but are subject to "crash risk." In contrast, the fundamental strategy has lower risk-adjusted returns, but is less prone to crash risk, because the realization of crash risk coincides with corrections towards fundamentals. In particular, the fundamental strategy outperformed carry trades during the recent global financial crisis. Building on these results, we present early warning indicators for potential turbulence in the currency market.

Series:

Working Paper No. 2010/039

Subject:

Currencies Exchange rate adjustments Exchange rates Foreign exchange Money Purchasing power parity Real effective exchange rates

English

Publication Date:

February 1, 2010

ISBN/ISSN:

9781451962864/1018-5941

Stock No:

WPIEA2010039

Pages:

34

Please address any questions about this title to publications@imf.org