The profitability of carry trades
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The uncovered interest parity (UIP) condition suggests that carry trades whereby investors borrow in the low interest rate currency and invest in the high interest rate currency should not result in excess profits over the long run. In this paper, we test the significance of the conventional empirical failure of UIP condition. Using the four bilateral pound parities we fail to detect significant excess carry trade profits for the yen, euro and swiss franc–pound parities. The only parity for which the carry trade consistently makes excess profits is the dollar–pound parity. This result is somewhat surprising as this is the currency pair with the lowest interest rate differential.
KeywordsCarry-trade Efficient market hypothesis Profitability tests Uncovered interest parity
JEL ClassificationF30 F31 F37
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