Destabilizing carry trades

Guillaume Plantin (1, 2) , Hyun Song Shin (3)

1 ECON - Département d'économie (Sciences Po)
2 Tepper School of Business
3 Princeton University

We offer a model of currency carry trades in which carry traders generate self-sustained excess returns if they coordinate on supplying excessive capital to a target economy. The interest-rate differential between their funding currency and the target currency is their coordination device. Such self-fulfilling pro table currency trades arise when the central bank of the target economy ignores the impact of carry-trade in flows on domestic asset prices, and responds only to their effect on inflation. We solve for a unique equilibrium that exhibits the classic pattern of the carry-trade recipient currency appreciating for extended periods, punctuated by sharp falls.

Mots clés: Currency Carry Trades; Inflation Targeting; Financial Instability

Domaines: Economies et finances

Guillaume Plantin, Hyun Song Shin. Destabilizing carry trades. 2015. ⟨hal-03459933⟩