Australian Dollar carry trades: Time varying probabilities and determinants

Abstract

This paper investigates the nature and the determinants of the Australian dollar (AUD) carry trades using a Markov regime shifting model over the period 2 Jan 1999 to 31 Dec 2012. We find that the AUD could have been used, except for a number of short periods notably surrounding the outbreak of the GFC, as an investment currency in a carry trade regime. For daily horizon, prior to September 2008, carry trade probabilities are significantly lower in response to higher realized volatility of the USD/AUD, number of trades, the announcements of unexpected inflation and unemployment in Australia. They are significantly higher when order flows are positive (more buyer than seller initialed trades of AUD) and when RBA policy interest rate unexpectedly increase. At weekly horizon, realized skewness and net long futures position in the AUD contributed to the carry trade probabilities. On the other hand, post-September 2008 period shows a breakdown in the relationship between the carry trade probabilities and their determinants.