Sunday, April 06, 2008

The carry trade

Markus Brunnermeier, Stefan Nagel, Lasse Pedersen look at the carry trade.

Our theoretically that securities that speculators invest in have a positive average return and a negative skewness. The positive return is a premium for providing liquidity and the negative skewness arrises from an asymmetric response to fundamental shocks: shocks that lead to speculator losses are amplified when speculators hit funding constraints and unwind their positions, further depresing prices, increasing the funding problems, volatility, and margins, and so on. Conversely, shocks that lead to speculator gains are not amplified.

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