Exchange policy credibility through the lens of the carry trade: The Mexican peso and the Brazilian real.

  • Carlos Fernández-Herraiz Instituto de Estudios Bursátiles
  • Antonio Javier Prado Domínguez Universidade da Coruña
  • Carlos Pateiro-Rodriguez Universidade da Coruña
  • Jesus M. Garcia-Iglesias Universidad de Extremadura
Keywords: Currency carry trade, Sharpe ratio, Exchange Policy credibility, Shadow bankin


Exchange credibility is a valuable asset for currency policymakers. In this article we intend to analyse exchange credibility from the perspective of carry trade speculators. Global speculators' access to shadow banking financing allows them to build dynamic carry trade strategies that are a source of potential financial instability. Our view is that the existence of dynamic carry trade opportunities offers a tool for monitoring how market participants asses the credibility of exchange policies. We use the long term performance of different carry trade dynamic specifications to understand how different is the market view of exchange policy credibility in the case of two leading Latin America countries, Mexico and Brazil. Our empirical research covers data from May of 2000 to May 2018. In light of the evidence presented, we recognize that Mexican peso exchange policy is considered credible but Brazilian real exchange policy is not considered credible during the sample period.


Barroso, P., & Santa-Clara, P. (2015). Beyond the carry trade: Optimal currency portfolios. Journal of Financial and Quantitative Anaysis 50(5), 1037-1056. doi:

Cochrane, J. (1999). New facts in finance. NBER Working paper num. 7169. doi:

Darvas, Z. (2008). Leveraged carry trade portfolios. Discussion Papers, Institue of Economics, Hungarian Academy of Sciences, MT-DP-2008/22.doi:

Fama, E. (1984). Forward and spot exchange rates. Journal of Monetary Economics 14, 319-338. doi:

Financial Stability Board (2018). Global shadow banking monitoring report.

Gabor, D. (2014). The IMF´s Rethink of Global Banks: Critical in Theory, Orthodox in Practice. Governance 28(2), 199-218. doi:

Hansen, L., & Hodrick, R. (1980). Forward exchange rates as optimal predictors of future spot rates: an econometric analysis. Journal of Political Economy 14(3), 319-338. doi:

Ilmanen, A. (2012). Do financial markets reward buying or selling insurance or lottery tickets? Financial Analysts Journal 68(5), 26-36. doi:

Jordá, O., & Taylor, A. (2009). The carry trade and fundamentals: Nothing to fear but FEER itself. NBER Working paper num. 15518. doi:

Krugman, P., Rogoff, K., Fisher, S., & McDonough, W. (1999). Currency Crises. In M. Feldstein, International capital flows. Chicago: University of Chicago Press, 421-470.

Meese, R., & Rogoff, K. (1983). Empirical Echange Models of the Seventies. Do They Fit out of Sample? The Journal of International Economics 14, 3-24. doi:

Osler, C. (2012). Market Microestructure and the Profitability of Currency Trading. Annual Review of Financial Economics 4(1), 469-495. doi:

Prado-Dominguez, J., & Fernandez-Herraiz, C. (2015). A Sharpe ratio based measure for currencies. European Journal of Goverment and Economics 4(1), 67-75. doi:

Rodrik, D. (2006). The social cost of foreign exchange reserves. NBER Working paper 11952. doi:

Shiller, R. (2012). Finance and the good society. New Jersey: Princeton University Press.

How to Cite
Fernández-Herraiz, C., Prado Domínguez, A. J., Pateiro-Rodriguez, C., & Garcia-Iglesias, J. M. (2018). Exchange policy credibility through the lens of the carry trade: The Mexican peso and the Brazilian real. European Journal of Government and Economics, 7(2), 123-137.