Journal
JOURNAL OF FINANCIAL ECONOMICS
Volume 99, Issue 1, Pages 60-75Publisher
ELSEVIER SCIENCE SA
DOI: 10.1016/j.jfineco.2010.07.006
Keywords
Hedge funds; Currency speculation; Carry trades
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In this paper, we study a two-country general equilibrium model with partially segmented financial markets, where hedge funds emerge endogenously. Empirically, we show that the hedge fund investment strategy predicted by our model, which we call the risk-adjusted carry trade strategy, explains more than 16% of the overall hedge fund index returns and more than 33% of the fixed income arbitrage sub-index returns. The flow of new money to hedge funds affects market interest rates, exchange rates, and both the hedge funds' contemporaneous and expected future returns as predicted by the model. (C) 2010 Elsevier B.V. All rights reserved.
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