Carry trades, momentum trading and the forward premium anomaly

Explaining Exchange Rate Anomalies in a Model with Taylor-Rule Fundamentals and Consistent Expectations

“…Related mechanisms are proposed by ), Ilut (2012), and Yu (2013. In contrast, we postulate that agents have distorted beliefs about the law of motion for exchange rates, not 7 For recent evidence, see Baillie and Chang (2011) and Baillie and Cho (2014). 8 See Engel (1996) for a survey of this large literature and Engel (2014) for a review of new developments in this …eld.…”

“…For other applications of consistent expectations to asset pricing or in ‡ation, see Sögner and Mitlöhner (2002), Branch and McGough (2005), Evans and Ramey (2006), Lansing (2009Lansing ( , 2010, and Hommes and Zhu (2014). 2 For evidence of variability in estimated UIP slope coe¢ cients, see Bansal (1997), Flood and Rose (2002), Baillie and Chang (2011), Baillie and Cho (2014), and Ding and Ma (2013). investors "may need some time to think about trades before executing them, or that they simply cannot respond quickly to recent information. " We assume that enough time has gone by for agents to have discovered the parameters governing the law of motion for the fundamental driving variable, thus allowing them to infer the fundamental innovation, i.e., news.…”

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“…However, it has been noticed that currencies with higher interest rates tend to appreciate against low interest rate currencies, contradicting UIP. Many researchers such as Gyntelberg and Remolona (2007), Baillie and Chang (2011), and others tend to imply a link between the failures of UIP and profitability, Moosa and Burns (2012) state that, although the failure of UIP is a necessary condition for a profitable carry trade, it is not a sufficient enough condition.…”

The Profitability of Using Pegged Currencies in Carry Trade: A Case of Saudi Riyal

“…Baillie and Chang (2011) described carry trade as a speculation against UIP, while Gyntelberg and Remolona (2007) described it as nothing more than a bet against UIP. Although many researchers, such as Gyntelberg and Remolona (2007), Baillie and Chang (2011), and others, tend to imply a link between the failures of UIP and profitability, Moosa and Halteh (2012) state that, although the failure of UIP is a necessary condition for a profitable carry trade, it is not a sufficient enough condition. They argue that big movements in the currency markets which satisfy the failure of UIP might wipe out the interest rate differential and even produce a losing position.…”