An Empirical Analysis of Currency Carry Trade Strategies

AN EMPIRICAL STUDY OF CURRENCY CARRY TRADE STRATEGIES

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Table of Contents

INTRODUCTION AND LITERATURE REVIEW .......................................................................... 3 MONETARY POLICY IMPLICATIONS ..................................................................................................... 4 POSSIBLE SOLUTIONS OF THE “FORWARD PREMIUM PUZZLE”......................................................... 6 DATA DESCRIPTION......................................................................................................................... 9 METHODOLOGY.............................................................................................................................. 12 EMPIRICAL RESULTS .................................................................................................................... 18 CONCLUSION.................................................................................................................................... 26 APPENDIX .......................................................................................................................................... 27 BIBLIOGRAPHY ............................................................................................................................... 31

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Introduction and Literature review
The carry of an asset is the benefit one receives (if it is positive) or the cost one incurs (if it is negative) by holding it for a period of time. One can think of commodities where the holder of the asset incurs the cost of storage (grain silo rent, bank vault rent for gold bullion, etc.). We have positive carry in case of currency pairs if we take long position in the currency with the higher interest rate (investment currency) and a corresponding amount of short position in the currency with the lower interest rate (funding currency). This is not a case of arbitrage: arbitrage means risk-less profit but in the case of carry trade the trader

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