Critical Finance Review > Vol 6 > Issue 2

The Carry Trade: Risks and Drawdowns

Kent Daniel, Columbia University and National Bureau of Economic Research, USA, , Robert J. Hodrick, Columbia University, USA, , Zhongjin Lu, University of Georgia, USA,
Suggested Citation
Kent Daniel, Robert J. Hodrick and Zhongjin Lu (2017), "The Carry Trade: Risks and Drawdowns", Critical Finance Review: Vol. 6: No. 2, pp 211-262.

Publication Date: 05 Sep 2017
© 2017 K. Daniel, R. J. Hodrick and Z. Lu
Currency carry tradeCurrency risk factorsMarket efficiency


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In this article:
1. Introduction 
2. Background Ideas and Essential Theory 
3. Data 
4. Returns and Risks of the Carry Trade 
5. Dollar Neutral and Pure Dollar Carry Trades 
6. Downside Risk and the Carry Trade 
7. Analysis of the Hedged Carry Trade 
8. Drawdown Analysis 
9. Conclusions 


We find important differences in dollar-based and dollar-neutral G10 carry trades. Dollar-neutral trades have positive average returns, are highly negatively skewed, are correlated with risk factors, and exhibit considerable downside risk. In contrast, a diversified dollar-carry portfolio has a higher average excess return, a higher Sharpe ratio, minimal skewness, is unconditionally uncorrelated with standard risk-factors, and exhibits no downside risk. Distributions of drawdowns and maximum losses from daily data indicate a role for timevarying autocorrelation in determining negative skewness at longer horizons.