ON RETURN AND RISK IN CARRY TRADES: A CASE OF THE PAK RUPEE

Abstract

This paper examines return and risk in Japanese-yen-, Swiss-franc- and US dollarfunded carry trades in the Pak rupee over the period 1995:01-2010:06. Results show that carry trades outperform the S&P 500, Swiss and Nikkei 225 stock market indices. The average annualized returns in carry trades range between 12.03% to 16.70% with standard deviations between 24% to 44%, giving Sharpe ratios that range between 0.36 to 0.49, whereas the annualized returns on stock markets range between -3.4% to 7.19% with standard deviations between 55.08 to 71.19, giving Sharpe ratios between -0.03 and 0.12. The results also show that the yen-funded carry trade produces both the highest average annualized return and interest differential of 8.6% and 16.70% respectively, whereas the US-dollarfunded carry trade produces the lowest average annualized return and interest differential of 5.21% and 12.03% respectively. However, the percentage of positive returns in the latter is 24% higher than the percentage of positive returns in the former. In addition, carry trade produces the highest Sharpe ratio when the Pak rupee is paired with the US dollar rather than when it is paired with the Japanese yen and Swiss franc, implying that the risk-adjusted return is the highest in the Pak rupee pair with the US dollar

Keywords

• Uncovered interest parity, exchange rate and open economy

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