Sunday, April 06, 2008
It is rare that I leave an economics conference with information that will change my personal financial decisionmaking. But I was close yesterday. A fascinating discussion of a paper on the carry trade made me wonder whether I should put a little money there.
The carry trade refers to the act of borrowing from countries with low interest rates, lending to countries with high interest rates, and profiting from the interest rate differential. It is based on the hope that exchange rates will not move too much against you to wipe out the profit. In other words, it is gambling that a condition known as uncovered interest parity will not hold. In the past, this strategy has been a money-maker. That is, uncovered interest parity is a plausible hypothesis that empirical studies usually reject.
One thing I learned at the conference is that ETFs now make this strategy easy for small retail investors to pursue. The above chart is a simulated past performance from the ETF's website. It is similar to some of the results shown by the discussants at the conference.
Does the increased ease of the transaction mean that the market will become more efficient, so the strategy will no longer be profitable? Perhaps.