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Currency Carry Trades - Prudent Investments or Just a Lottery?

Kunz, Daniel and Korhonen, Jussi (2009)
Department of Business Administration
Abstract
Objectives: The objective of this study is to find out whether currency carry trades are
prudent investments or a pure lottery. To consider currency carry trades as a prudent
investment strategy they have to fulfill at least one of the following two criteria
• The risk-adjusted performance of currency-carry trades should match or
outperform the risk-adjusted performance of the equity indices. I.e. higher risk
should be awarded with adequately higher profits.
• Currency carry trades should be suitable as an alternative investment. I.e. the
correlation between the stock market and the currency carry trade returns should
be small or negative, especially in times of declining stock markets.
Theoretical Framework: According to the Uncovered... (More)
Objectives: The objective of this study is to find out whether currency carry trades are
prudent investments or a pure lottery. To consider currency carry trades as a prudent
investment strategy they have to fulfill at least one of the following two criteria
• The risk-adjusted performance of currency-carry trades should match or
outperform the risk-adjusted performance of the equity indices. I.e. higher risk
should be awarded with adequately higher profits.
• Currency carry trades should be suitable as an alternative investment. I.e. the
correlation between the stock market and the currency carry trade returns should
be small or negative, especially in times of declining stock markets.
Theoretical Framework: According to the Uncovered Interest Parity (UIP) a strategy
that involves borrowing in a low yielding currency and investing it in a high yielding
currency should not generate excess return. The high yielding currency is therefore
expected to decrease. Thus previous studies all concluded that the UIP does not hold.
Data and Methodology: The empirical part uses the one month interbank interest rate
and the mid-rate for the exchange rate. The time horizon is from Jan. 1st 1993 until April
27th. We used three different methods to evaluate the risk-adjusted performance (Sharpe
ratio, reward-to-VaR and conditional Sharpe ratio). To test the suitability as an alternative
investment we applied the linear correlation and the exceedance correlation.
Results and Findings: The findings support the research hypothesis that the riskadjusted
measures of currency carry trading portfolio outperform the equity indices.
Currency carry trades function as an alternative investment partly since criteria is not
entirely fulfilled. In bear markets correlation is high, whereas in bull markets it is low. (Less)
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author
Kunz, Daniel and Korhonen, Jussi
supervisor
organization
year
type
H1 - Master's Degree (One Year)
subject
keywords
Currency carry trade, return on carry, uncovered interest parity, risk-adjusted performance measure, Management of enterprises, Företagsledning, management
language
Swedish
id
1474515
date added to LUP
2009-06-04 00:00:00
date last changed
2012-04-02 17:52:25
@misc{1474515,
  abstract     = {Objectives: The objective of this study is to find out whether currency carry trades are
prudent investments or a pure lottery. To consider currency carry trades as a prudent
investment strategy they have to fulfill at least one of the following two criteria
• The risk-adjusted performance of currency-carry trades should match or
outperform the risk-adjusted performance of the equity indices. I.e. higher risk
should be awarded with adequately higher profits.
• Currency carry trades should be suitable as an alternative investment. I.e. the
correlation between the stock market and the currency carry trade returns should
be small or negative, especially in times of declining stock markets.
Theoretical Framework: According to the Uncovered Interest Parity (UIP) a strategy
that involves borrowing in a low yielding currency and investing it in a high yielding
currency should not generate excess return. The high yielding currency is therefore
expected to decrease. Thus previous studies all concluded that the UIP does not hold.
Data and Methodology: The empirical part uses the one month interbank interest rate
and the mid-rate for the exchange rate. The time horizon is from Jan. 1st 1993 until April
27th. We used three different methods to evaluate the risk-adjusted performance (Sharpe
ratio, reward-to-VaR and conditional Sharpe ratio). To test the suitability as an alternative
investment we applied the linear correlation and the exceedance correlation.
Results and Findings: The findings support the research hypothesis that the riskadjusted
measures of currency carry trading portfolio outperform the equity indices.
Currency carry trades function as an alternative investment partly since criteria is not
entirely fulfilled. In bear markets correlation is high, whereas in bull markets it is low.},
  author       = {Kunz, Daniel and Korhonen, Jussi},
  keyword      = {Currency carry trade,return on carry,uncovered interest parity,risk-adjusted performance measure,Management of enterprises,Företagsledning, management},
  language     = {swe},
  note         = {Student Paper},
  title        = {Currency Carry Trades - Prudent Investments or Just a Lottery?},
  year         = {2009},
}