Abstract
In this paper, we employ a unique dataset of actual US dollar (USD) forward positions against a number of currencies taken by so-called Commodity Trading Advisors (CTAs). We investigate to what extent these positions exhibit a pattern of USD carry trading or other patterns of currency trading over the recent period of the ultra-loose US monetary policy. Our analysis indeed shows that USD positions against emerging market currencies are characterised by a pattern of carry trading. That is, the USD, as the lower yielding currency, is associated with short positions. The payoff distributions of these positions, moreover, are found to have positive Sharpe ratios, negative skewness and high kurtosis. On the other hand, we find that USD positions against other advanced country currencies have a pattern completely opposite to carry trading which is in line with uncovered interest parity trading; that is, the lower (higher) yielding currency is associated with long (short) positions.
Highlights
In this paper, we employ and analyse a unique dataset of actual US dollar (USD) forward positions versus a number of emerging- and developed-market currencies
Under the assumption of the covered interest rate parity (CIP), this strategy can be implemented in the foreign exchange (FX) forward markets by taking long positions in currencies which are traded on the forward discount and short positions in currencies which are traded on the forward premium
Multivariate Johansen cointegration analysis techniques are employed to test for the existence and the number of cointegrated relationships between the USD forward positions (CNP), spot exchange rates (LogS) and forward exchange rates (LogF) in order to investigate how they are related over the long run
Summary
We employ and analyse a unique dataset of actual USD forward positions versus a number of emerging- and developed-market currencies. Our objective is to shed light on the characteristics of the currency trading styles implied by these positions during a recent sample period, with emphasis on USD carry trading.. Our objective is to shed light on the characteristics of the currency trading styles implied by these positions during a recent sample period, with emphasis on USD carry trading.1 The motivation behind this emphasis is the near-zero US interest rate over the vast majority of our sample period. The motivation behind currency carry trading is the well-established finding of the downward bias in the unbiasedness hypothesis (UH) predictions, i.e. the forward premium bias puzzle (see, for example, Fama, 1984; Frankel and Chinn, 1993; Bansal and Dahlquist, 2000; and Frankel and Poonawala, 2010, among others). The standard expression of this hypothesis is through the Fama regression of:
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