Cross-asset return predictability: Carry trades, stocks and commodities. (June 2016)

• Record Type: Journal Article
• Authors: Lu, Helen; Jacobsen, Ben
• Is Part Of: Journal of international money and finance. Volume 64(2016)
• Page Start: 62
• Page End: 87
• Publication Date: 2016-06
• Subjects: G11 -- G14 -- F31; Carry trade -- Gradual information diffusion -- Return predictability -- Safe-haven currencies -- Time-varying risk premium -- Vector auto regression; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2016.02.013
• Languages: English
• ISSNs: 0261-5606

Abstract

Highlights: Equity returns predict the short leg profits of carry trades. Commodity price changes predict the long leg profits. Consistent with gradual information diffusion instead of time-varying risk. One-directional predictability from commodities to stocks and stocks to currencies. Abstract: Equity returns predict carry trade profits from shorting low interest rate currencies. Commodity price changes predict profits from longing high interest rate currencies. The gradual information diffusion hypothesis (Hong & Stein, 1999) provides a ready explanation for these predictability results. These results cannot be explained by time-varying risk premia as stock returns and commodity price changes significantly predict negative carry trade profits. The predictability is one-directional, from commodities to high interest rate currencies, from commodities to stocks and from stocks to low interest rate currencies.