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Despite an attractive interest rate differential between China and foreign countries, existing capital control might prevent currency carry trade strategies to be executed. We focus on the copper market to study if trades are taken in order to execute carry trade strategies. We find that copper value is related to carry trade through the onshore-offshore interest differential, while the pegged nature of the USD/CNY exchange rate makes traders indifferent to the forward risk premium. We rule out the possibility of high average payoff due to peso problems, because risk factors are insignificant, implying that carry traders are either fully hedged on FX risks, or they are unconcerned about FX risks. [ABSTRACT FROM AUTHOR]

I document that Federal Reserve expansionary monetary policy has a positive impact on the excess returns arising from currency carry trades. I show that expansive monetary surprises are associated with an increase in future real interest differentials between high interest rate currencies and the US dollar, which leads to higher capital flows toward those currencies and an increase in their returns. Since this increase is not fully compensated by a decrease in the returns from the short position in low interest rate currencies, unexpected monetary expansions in the US result in higher carry trade returns. [ABSTRACT FROM AUTHOR]

The aim of this study is to analyze the main determinants of carry trade activity for Turkey, England and the USA in the periods when global risk perception is high and low. From the results of TVAR model, we concluded that interest rate differential is the main factor behind carry trade activity in the periods when global risk perception is high and low. We found that exchange rate uncertainty is an element that leads to giving up carry trade activity in the period when global risk perception is high while it doesn't have any significant effect in the period when global risk perception is low in Turkey and England. However, we determined that investors in the USA continue to carry trade activity although exchange rate uncertainty rises. [ABSTRACT FROM AUTHOR]

Carry trade refers to a risky arbitrage in interest rate differentials between two currencies. Persistent excess carry trade returns pose a challenge to foreign exchange market efficiency. Using a data set of 10 currencies between 1990 and 2017, we find (i) a machine learning model, long short-term memory (LSTM) networks, forecast carry trade returns better than linear and threshold models and other machine learning models; and (ii) excess carry trade returns deteriorate after the 2007–2008 global financial crisis in all model forecasts, indicating that the uncovered interest rate parity may still hold in the long run. [ABSTRACT FROM AUTHOR]

In this paper we derive a new model on exchange rate response to a lasting higher interest rate level. Contemporary models do not provide a convincing explanation for this relationship, but recent research suggests that models based on demand-pull effects to be somewhat confined to small funding cost increases. This would make cost-push effects more relevant when the interest rate differential (IRD) is larger and longer-lasting. The new model accounts for cost-push effects and suggests that a persistent higher IRD can evoke multiple responses, including currency depreciation, specialization, inflation, and wage drift. The model suggests that excessive long-lasting IRD can spark a chronic interaction between inflation and currency depreciation. Empirical data substantiate the prediction capability of the new model. We also demonstrate how the uncovered interest rate parity (UIP) principle is a special case, which can explain its empirical research anomalies, and when carry trade is a profitable investment strategy.

The returns to carry trades are controversially discussed. There seems to be no unifying risk-based explanation of currency returns and stock returns, while the countries' interest rate differential plays a leading part in the carry-trade performance. Therefore, this paper addresses carry-trade returns from a risk-pricing perspective and examines if these returns can be connected to cross-country differences in risk pricing in the interest-rate market compared to the stock market. Data from Thomson Reuters Datastream and Federal Reserve Economic Data covering Australia, Japan, New Zealand, Switzerland and the United States were analyzed based on GMM estimation. The results indicate significant and persistent cross-country differences in risk aversion in the interest-rate market compared to the implied risk aversion in the stock market. This may offer opportunities for risk arbitrage and, therefore, a risk pricing-related explanation of carry-trade returns. [ABSTRACT FROM AUTHOR]

The article analyzes the carry trade strategy in which, according to common definition, traders borrow a currency that has a low-interest rate and use the funds to buy a different currency that is paying a higher interest rate. The aim of this work is to form the optimal strategies and carry trade portfolio. The task of our study was to study the interdependence between the yield of the carry trade strategy and the USA stock market on the basis of a mathematical approach and offer a portfolio of currencies with the highest historical yield over the past five years. The author used the model of relative risk aversion. We analyzed data on exchange rates, forward premium and real exchange rates for the Eurozone, as well as for countries of the Organization for Economic Cooperation and Development (OECD) such as Australia, Brazil, China, Japan, New Zealand, Russia, Switzerland, the United Kingdom and the United States of America. Carry trade’s yield is not tied to standard risk factors. Popular funding currency — the yen has experienced a strong jump of volatility as a result of the 2008–2009 crisis. A possible explanation for this reversal is investors’ appetite for risk. The author concluded that the most common carry trade strategies in the period from 2009 to 2014 were formed on the basis of two financing currencies (Japanese yen and the US dollar) and three investment currencies (Australian dollar, New Zealand dollar and Chinese yuan). After 2014, the US dollar ceases to be the funding currency, giving way to the Euro. The optimal carry trade strategy is borrowing in the currencies of developed countries (EUR, JPY) and investing in the currencies of energy producing countries (RUB, BRL). There is a negative relationship between the volume of transactions based on the carry trade strategy and the yield of shares in the financing country. There is also a significant link between the yield of the carry trade strategy and the profitability of the USA stock market.

Carry trade is a speculative financial transaction and a leveraged exchange rate position. Thus, a sudden unwinding in carry trade position leads to a sharp depreciates in the high-interest currency and to increase exchange rate volatility. It can cause global imbalances and financial crises and therefore it can ensue as a source of financial fragility and instability. In this study, we examined effects of unwinding of carry trade on financial variables in regimes when interest rate differential and TL/USD exchange rate volatility are high and low, over the period of January 2005-September 2017 in Turkey. From the results of this study, we concluded that a sudden unwinding of carry trade position led to decrease of interest rate and BİST 100 return and increase of inflation rate in regimes when interest rate differential is high and low. So-called unwinding led to depreciate Turkish Lira and decrease of BİST 100 return in regimes when exchange rate volatility is high and low. [ABSTRACT FROM AUTHOR]

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This paper applies a mixed effect model to investigate the relationship between international equity returns and forward discount sorted currency returns from three base currencies (i. e., US dollar, euro, and pound sterling). Empirical results using the portfolio approach show that high-interest rate currencies co-move positively while low-interest rate currencies co-move negatively, suggesting that foreign equity excess returns can help to explain investment in currency markets, providing a partial resolution to the uncovered interest parity conundrum. Furthermore, we show that global equity market returns, volatility, and liquidity correlate well with currency returns. [ABSTRACT FROM AUTHOR]

DeMiguel et al. [DeMiguel V, Garlappi L, Uppal R (2009) Optimal versus naïve diversification: How inefficient is the 1/ N portfolio strategy? Rev. Financial Stud. 22(5):1915-1953] showed that in the stock market, it is difficult for an optimized portfolio constructed using mean-variance analysis to outperform a simple, equally weighted portfolio because of estimation error. In this paper, we demonstrate that portfolio optimization can be made to work in currency markets. The key difference between the two settings is that in currency markets interest rates provide a predictor of future returns that is free of estimation error, which permits the application of mean-variance analysis. We show that over the last 26 years, a mean-variance efficient portfolio constructed in this fashion has a Sharpe ratio of 0.91, versus only 0.15 for the equally weighted portfolio. We also consider the practical implementation of this strategy. This paper was accepted by Neng Wang, finance. [ABSTRACT FROM AUTHOR]

We investigate the relation between foreign exchange (FX) order flow and the forward bias. We outline a decomposition of the forward bias according to which a negative correlation between interest rate differentials and order flow creates a time-varying risk premium consistent with that bias. Using 10 years of data on FX order flow, we find that more than half of the forward bias is accounted for by order flow-with the rest being explained by expectational errors. We also find that carry trading increases currency-crash risk in that order flow generates negative skewness in FX returns. [ABSTRACT FROM AUTHOR]

We carry out a value-at-risk (VaR) analysis of an extremely popular strategy in the currency markets, namely, 'carry trades,' whereby a position purchased in high interest rate currencies is funded by selling low interest rate currencies. Since the natural outcome of the truncated normal distribution of interest-rate spreads combined with the normal distribution of exchange rate returns is a skew-normal distribution, we consider a skew-normal innovation with zero mean for our analysis of carry trade returns using generalized autoregressive conditional heteroskedasticity (GARCH) models. The stress testing results reveal that skew-normal or densities are suitable for the measurement of VaR for carry trade returns involving, for example, taking up a long position in Australian Dollars or Argentine Peso which are funded by selling Japanese Yen. [ABSTRACT FROM AUTHOR]

Abstract: The international dollar standard is malfunctioning. Near zero U.S. short-term interest rates launch massive hot money outflows by carry traders into emerging markets (EM) in Asia and Latin America. Each EM central bank buys dollars to prevent its currency from appreciating but loses monetary control. Despite EM currency appreciation, average inflation in EMs is now much higher than in the old industrial economies—and world commodity prices are bid up sharply. This inflation on the dollar''s periphery only registers in the U.S. CPI with a long lag. But the more immediate effect of the Fed''s zero interest rate is to upset the process of bank intermediation within the American economy. Bank credit continues to be weak while employment languishes. The (second) avalanche of hot money outflows into emerging markets (EM) began when the Fed reduced the interest rate on Federal Funds to virtually zero in December 2008—and other industrial countries followed suit. But the outbreak of a banking crisis in Europe with counter party risk in the summer of 2011 led to a global tightening of bank credit on which “carry traders” depend for financing hot money flows and long positions in primary commodities. So they had to sell off their foreign exchange (mainly EM) assets and long positions in commodities to get back into dollars or yen. The result is that EM currencies and commodity prices—with the exception of the price of oil—fell and remained weak through December 2011, while the dollar strengthened and the Japanese government intervened several time in the last half of 2011 to prevent the yen from appreciating. This cycle illustrates the main point of the paper: wide interest rate differentials across currencies make the world monetary system much more fragile whatever the exchange rate regime. “Reform” efforts should focus much more on international monetary harmonization that limits interest differentials while accepting the need for exchange rate buffers, such as capital controls, to limit hot money flows. Once the European banking crisis recedes (if ever), the large interest differential—near zero interest rates in the United States and much higher natural interest rates in the high growth EMs—will, in 2012, set off another cycle of hot money flows from the center to the periphery with rising commodity prices. [Copyright &y& Elsevier]

A few policy recommendations become apparent to avoid depreciation relative to other regional currencies when examining intra-Asian exchange rates during the most recent credit crisis. One, avoid large fiscal deficits. Two, avoid high inflation and current account deficits in order to maintain low interest rates to avoid depreciation from the unwinding of the carry trade. Third, build large official reserves or, more importantly, build large reserves of foreign currency assets. Additional results show an unexplained depreciation of the Australian dollar and the Indian rupee and appreciation of the Thai baht as the TED spread widened and credit crisis worsened. [ABSTRACT FROM AUTHOR]