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unit impulses, that is, for eτ it is a 1% depreciation in the currency; for qτ it is a 1%

d e v i a t i o n f r o m t h e l o n g - r u n P P P e q u i l i b r i u m ; f o r ) ( * τ τ i i i t i s a 1 % i n c r e a s e i n U . S .

interest rates relative to abroad; and for VXτ a unit increase in volatility (the sample

mean is approximately 10 units).

Figure 1 – The Dynamics of Carry Trade Profits

.4

.3

.2

.1

.0

  • -

    .1

1

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2.0

1.6

1.2

0.8

0.4

0.0

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    0.4

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    0.8

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Exchange Rate Shock

Int. Rate Shock

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.0012

.00

.0008

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    .04

.0004

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    .08

.0000

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    .0004

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    .0008

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    .0012

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PPP Shock

VX Shock

Notes: Local projections estimates based on expression (2) in the paper with fixed-effect panel estimates. Marginal one standard error-bands displayed along with coefficient estimates. Each graph displays the response of carry trade profits to a one unit shock in each of the variables displayed.

It is worth noting that the response to q is particularly important for several reasons.

First, because it measures the deviation from long-run real exchange rate equilibrium (which could originate from any number of factors related to movements in exchange

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