A Portfolio Balance Approach to Carry Trade (Job Market Paper) Carry trade, a crossborder investment strategy to take advantage of the
interest rate differential between countries, is studied in a portfolio
equilibrium approach of exchange rate determination. Since an orderly
behavior of investors with rational expectations cannot replicate a large
fluctuation of the exchange rate and accompanying ebbs and flows in the
position of foreign assets, a new type of investors with adaptive expectations
— chartists — is augmented. With two types of investors in play, the model
reproduces basic facts on carry trades that building up foreign positions
comes along appreciation of the investment currency and unwinding forces
drastic depreciation of the currency. The outcome of the model also parallels
empirical observations on carry trades.
