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    The Returns to Currency Speculation

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    Date
    2006
    Authors
    Burnside, A Craig
    Eichenbaum, Martin
    Kleshchelski, Isaac
    Rebelo, Sergio T
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    Abstract
    Currencies that are at a forward premium tend to depreciate. This `forward-premium puzzle` represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. In practice bid-ask spreads are an increasing function of order size. In addition, there is price pressure, i.e. exchange rates are an increasing function of net order flow. Together these frictions greatly reduce the profitability of currency speculation strategies. In fact, the marginal Sharpe ratio associated with currency speculation can be zero even though the average Sharpe ratio is positive.
    Type
    Journal article
    Subject
    currency speculation
    exchange rates
    forward premium puzzle
    sharpe ratios
    Permalink
    https://hdl.handle.net/10161/2041
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    Scholars@Duke

    Burnside

    A. Craig Burnside

    Mary Grace Wilson Distinguished Professor
    Burnside’s fields of specialization include macroeconomics and international finance. His recent research focuses on foreign exchange markets, empirical methods in finance, and the behavior of prices in housing markets. He has published articles in a number of academic journals, including the American Economic Review, the Journal of Political Economy, the Review of Economic Studies, and the Review of Financial Studies. He is a Research Associate of the National Bure
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    Articles written by Duke faculty are made available through the campus open access policy. For more information see: Duke Open Access Policy

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