Carry Trade Research Articles

Carry Trades and FX Risk Buffers: Foreign Currency Debt of Emerging Market Firms

Abstract The surge in foreign currency (FC) corporate debt in emerging economies has sparked concerns about macroeconomic stability, heightened by speculation about non-financial firms engaging in carry trades. Using firm-level data on the currency denomination of both assets and liabilities, we find evidence of firms' carry trades: firms save in local currency liquid assets and earn higher interest income after issuing short-term FC debt. They also set aside FC liquid assets as FX risk buffers. A large degree of heterogeneity in incentives is observed. Notably, listed firms participate more in carry trades and allocate less FX risk buffers than non-listed firms.

Regulating Carry Trades: Evidence from Foreign Currency Borrowing of Corporations in India

Abstract We establish that macroprudential controls limiting capital flows can curb risks arising from foreign currency borrowing by corporates in emerging markets. Firm-level data show that Indian firms tend to issue more foreign currency debt when the interest rate differential between India and the United States is higher. This “carry trade” relationship, however, breaks down once regulators institute more stringent interest rate caps on borrowing; in response, riskier borrowers cut issuance most. Prior to adoption of this macroprudential measure, stock price exposure of issuers to currency risk rises after issuance, as witnessed during the “taper tantrum” episode of 2013; this source of vulnerability is nullified by the measure, as confirmed during the October 2018 oil price shock and the COVID-19 outbreak. We find no evidence of the policy’s efficacy being undermined by leakage or regulatory arbitrage.

The out-of-sample performance of carry trades

We carry out a large-scale investigation of the reliability of the profitability of carry trade strategies, using foreign exchange data for 48 countries over 36 years, employing reality check, superior predictive ability test, and stepwise tests to correct for data-snooping bias (the factor of luck in model selection). Carry trade strategies chosen as profitable in one period are generally not profitable in an ensuing out-of-sample sample period, especially after correcting for data-snooping and even after allowing for learning and stop-loss strategies. Any evidence of consistency in carry trade profitability that is found is concentrated in a relatively brief historical period, 1998-2005. We further investigate particular currency pairs that may drive the out-of-sample profitability during this period, and find their performance to be unstable in general. Our findings thus highlight the instability and the importance of chance or luck in generating profits from carry trades.

Cyclical and Persistent Carry Trade Returns and Forward Premia

Cyclical and Persistent Carry Trade Returns and Forward Premia

The boom of corporate debt in emerging markets: Carry trade or save to invest?

The decline in international interest rates following the global financial crisis encouraged firms in emerging markets to increase their corporate bond issuance abroad. Evidence shows that issuing offshore debt increases cash holdings, suggesting firms may exploit interest rate arbitrage. We argue that increasing contemporaneous cash holdings may also be undertaken for a “save to invest” motive to finance future investment opportunities. Using a sample of nonfinancial listed firms from 15 emerging market economies from 2001 to 2016, we show that companies accumulate cash when carry trade is favorable; however, we find that the increased cash holdings substantially revert in the following two periods, consistent with arguments for a “save to invest” motive. Indeed, offshore debt has a significant impact on both current and next-year investment.

Tobin Tax, Carry Trade, and the Exchange Rate Dynamics

Tobin Tax, Carry Trade, and the Exchange Rate Dynamics

From Carry Trades to Trade Credit: Financial Intermediation by Non-Financial Corporations

From Carry Trades to Trade Credit: Financial Intermediation by Non-Financial Corporations

The Risk and Return of Cryptocurrency Carry Trade

The Risk and Return of Cryptocurrency Carry Trade

The Impact of Currency Carry Trade Activity on the Transmission of Monetary Policy

The Impact of Currency Carry Trade Activity on the Transmission of Monetary Policy

Carry Trade and Capital Market Returns in South Africa

This paper assesses the extent to which carry trade operations affect the performance of equity and bond markets in a target country, South Africa, by considering the US and the euro area as the funding countries. A two- and three-factor capital asset pricing model (CAPM) is employed to assess whether the pricing of equity and bond markets in South Africa depends on the US dollar/rand and euro/rand carry trade returns. Moreover, the paper uses the quantile regression technique to assess whether this pricing varies with the distribution of the equity and bond returns. The findings support that the US- and euro-funded carry trade are essential factors for the pricing of equity and bond markets in South Africa. Moreover, the results of the two-factor model show a negative relationship between the equity excess return and the US-carry trade returns at lower quantiles of the equity market returns. The positive relationship is observed in the upper quantiles of the equity market. The negative relationship means that carry trade activities reduce equity market returns during a bear market as investors close out their position when conditions in the equity market become unfavourable. The results of the three-factor model, controlling for the global volatility or uncertainty, show that carry trade investors exit the equity market to invest in the bond market when global uncertainty rises. This finding shows that carry trade investors choose less risky assets during rising global uncertainty.

Currency Carry Trade by Trucks: The Curious Case of China’s Massive Imports from Itself

AbstractWith capital controls, the standard financial market transactions needed for currency carry trade are hard to implement. Using detailed trade data reported by both the mainland Chinese and Hong Kong’s governments, we present evidence that indirect currency carry trade likely takes place via round-trip reimports. We also show that greater state control in terms of more state-owned firms does not reduce such “carry trade by trucks.”

Sovereign Defaults and Currency Crashes: Insurance, Carry Trade, and Quanto

Sovereign Defaults and Currency Crashes: Insurance, Carry Trade, and Quanto

Macro News Effects on Exchange Rates: Difference between Carry Trade Target and Safe-haven Currencies

Macro News Effects on Exchange Rates: Difference between Carry Trade Target and Safe-haven Currencies

Currency Carry Trade by Trucks: The Curious Case of China's Massive Imports from Itself

Currency Carry Trade by Trucks: The Curious Case of China's Massive Imports from Itself

What Factors Affect the RMB Carry Trade Return for Sustainability? An Empirical Analysis by Using an ARDL Model

With the internationalization of RMB and the openness of China’s capital account, the amount of foreign institutions investing in China has increased significantly. Based on China’s daily data from January 2007 to September 2021, this study investigated the factors that affect the RMB carry-trade return for sustainability. By comparing the results of the carry return before and after the foreign-exchange reform on 11 August 2015, this study found that the RMB carry return has become more traceable after the exchange-rate reform. Meanwhile, the model fitting degree of explaining the RMB carry return was higher, and there were fewer missing variables. Therefore, this study found that after the RMB-exchange-rate mechanism became more market oriented, the RMB carry return became more reasonable, and the carry trade can play a better role in foreign-exchange pricing. Meanwhile, after using the RMB non-deliverable forwards (NDF) to construct a carry-trade position to perform the robustness test, such results were consistent. With different results before and after the exchange-rate reform, this study can provide references for policy makers and investors for sustainable development.

Carry Trade, Exchange Rates, and the Balance-of-Payments

Abstract This paper presents a partial equilibrium model that integrates interest rate arbitrage with the balance-of-payments constraint to determine the real exchange rate. The sequential logic is the following: (i) carry-trade determines the term premium, with the spot rate showing greater volatility than the forward rate, (ii) uncovered interest rate parity determines the spot rate based on the real exchange rate consistent with a financial constraint, defined as a stable ratio of foreign reserves to foreign debt; and (iii) the trade balance consistent with the financial constraint determines the long-run real exchange rate for a given ratio of domestic to foreign income.

The Relationship between Carry Trade and Asset Markets in South Africa

This paper investigates the extent of volatility or risk spillovers between the currency carry trade and asset markets, namely the equity and bond markets, in South Africa to infer the extent of the connectivity between the two markets. The carry trade operation examined in this paper involves two strategies, both of which use the South African rand as the investment currency, with the U.S. dollar and the Japanese yen as the funding currencies. The vector autoregressive BEKK-Generalised Autoregressive Conditional Heteroscedastic (multivariate VAR-BEKK-GARCH) model is used to this end. Moreover, the paper assesses the dynamic correlation between each currency carry trade and asset markets to infer the time-varying dependence between the two markets. The results of the empirical analysis show evidence of volatility spillover between the carry trade returns and the two asset market returns. The extent of the spillover depends on the choice of the funding currency, with the U.S. dollar-funded strategy transmitting more shocks to the South African equity market compared to the bond market. Moreover, the synchronisation of the dynamic correlation between each asset market and the currency carry trade returns shows that any possibility of arbitrage is precluded in the currency carry trade market.

To hedge or not to hedge: Carry trade dynamics in the emerging economies

In this paper, we show that the carry strategy matters in the emerging markets in the sense that the dollar neutral carry strategy outperforms the dollar carry strategy. We also show that carry trade is not a profitable strategy, compared to the returns from U.S. stocks and/or U.S. dollar risk-free rate. Our findings indicate that risk factors explain the dollar carry strategies better than the dollar neutral strategy particularly in the post-crisis period. Because emerging markets are riskier than developed ones, investors are expected to hedge using FX options. However, we find that hedging carry trade is not a good idea in the emerging markets because crash risk that is priced in the options seems to evaporate carry profits.

A machine learning approach to forecasting carry trade returns

ABSTRACT 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.

Portfolio of Carry Trade Using Indian Rupees

In this study, we have considered the portfolio of carry trade along with bond and equity. The interior point method and non-dominated sorting genetic algorithm II have been used for optimization. The criteria for the portfolio are the weighted sum of risk and return, utility maximization, diversification ratio and Rao’s quadratic entropy. We find that the interior point method with weighted sum of risk and return gives the best result.