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A Strategic Market Game of Carry Trades and Equilibrium Profits

We formalize carry trade in a two-country, two-period general equilibrium strategic market game model of an economy with no uncertainty where agents are not price takers. We show that when carry trade occurs at a Nash equilibrium it is profitable and is identified with the failure of the uncovered interest rate parity condition. Carry trade profits are attributed to asymmetric elasticities in currency or credit markets across time. Furthermore, at equilibrium, real national interest rates may not equalize across countries thus violating the standard international Fisher effect.