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Destabilizing carry trades

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Abstract

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.
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Dates and versions

hal-03459933 , version 1 (01-12-2021)

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