Joint Accounting and Finance - Econometrics and Business Statistics Seminar: David Rapach, Washington University in St. Louis

Title: The Rise and Fall of the Carry Trade: Links to Exchange Rate Predictability

2020.02.04 | Pernille Vorsø Jachobsen

Date Wed 03 Jun
Time 14:15 15:15
Location Online

Presenter: David Rapach, Washington University in St. Louis

Title: The Rise and Fall of the Carry Trade: Links to Exchange Rate Predictability

Area of research: Assets Pricing, Financial Economics, International Finance

Abstract:

We investigate out-of-sample exchange rate predictability in a high-dimensional panel predictive regression model that includes numerous country characteristics and their interactions with a variety of global variables. To avoid the overfitting problem that plagues conventional estimation of high-dimensional models, we estimate the panel predictive regression model via the elastic net, a machine learning technique based on penalized regression. The elastic net forecasts significantly outperform the no-change benchmark forecast that has proven difficult to beat in the literature. Out-of-sample exchange rate predictability becomes considerably stronger starting in the fall of 2008 during the worst stage of the global financial crisis. We show that exchange rate predictability can substantially improve the performance of conventional carry trade strategies: a smart carry portfolio that incorporates the information in the elastic net forecasts markedly improves portfolio performance in late 2008 and thereafter.

Host: Erik Christian Montes Schütte

Economics and Business Economics, Accounting and Finance Seminar Series