Stats › Currencies and commodities › Carry trade
The currency carry trade
Borrow where rates are low, lend where they're high, and pocket the difference. If exchange rates behaved the way the textbook says, that difference would get wiped out by the high rate currency falling. For most of the last fifty years it hasn't been.
That's the carry trade, and it is the oldest and best documented anomaly in foreign exchange. It has a founding paper from 1984, a pile of measured Sharpe ratios, a well known way of dying, and two spectacular case studies of it dying: October 2008 and August 2024.
I put this page together because the headline Sharpe ratio gets quoted constantly and the two things that matter more almost never do. One, what the number becomes after transaction costs. Two, what has happened to the underlying regression since 2008. Both are below, sourced and dated.
Fama's 1984 regression of spot changes on the forward premium produced negative slope coefficients, the opposite of what uncovered interest parity predicts, over 31 Aug 1973 to 10 Dec 1982 across nine currencies. Measured carry returns since: 4.6% a year at a Sharpe of 0.89 for Burnside, Eichenbaum and Rebelo over Feb 1976 to Dec 2010, against 0.41 for US equities on the same window. But Lustig, Roussanov and Verdelhan's 0.99 Sharpe falls to 0.54 once you pay bid-ask spreads and to 0.40 in developed currencies only. The trade dies violently: AUD/JPY fell 45.7% between 21 Jul and 27 Oct 2008, and the dollar fell 12.0% against the yen between 11 Jul and 5 Aug 2024. And the Fama coefficient itself flipped sign after 2008, from -5.209 to +2.589 for the euro on one published estimate.
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