Carry Trades and Monetary Conditions

This paper investigates the relation between monetary conditions and the excess returns arising from currency carry trades. The results indicate that carry trade average return, Sharpe ratio and downside risk differ substantially across monetary conditions before the onset of the financial crisis in 2008. Specifically, expansive policy shifts in the US result in a decrease in inter-national risk aversion, which in turn leads to a compression in currency risk premia and higher carry trade returns. By contrast, Fed monetary policy is not able to affect international risk aversion and carry trade returns during the crisis and Zero Lower Bound (ZLB) period, when the economic recession reduced the propensity of investors to take on risk exposures