The carry trade phenomenon in foreign exchange

Abstract

In this paper we document different aspects of carry trades. Carry trade is a strategy based on the failure of the UIP. We provide a detailed discussion about the forward premium puzzle, an anomaly in F.X market which implies that excess returns on foreign currency investments are predictable. In addition we document the puzzle in a large currency sample, using the least square method. Furthermore the term efficient market is under consideration. Investors search for inefficiencies within the market. We apply co integration and Granger Causality tests on exchange rates to test the weak form of F.X efficiency. Finally carry trade returns are analyzed and we figure out that investors are subject to a “crash risk”.