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

Year 2012, Volume: 4 Issue: 1, 201 - 214, 01.06.2012

Razzaque H. Bhatti

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

References

• Banyard, Peter (1998), “Capitalism Gone Barmy Needs a Capitalist Solution”,
• Credit Management, November, pp. 38-40. Beranger, Florence, Galati, Gabriele, Tsatsaronis, Kostas and von Kleist, Kleist (1999), “The Yen Carry Trade and Recent Foreign Exchange Market Volatility”,
• BIS Quarterly Review, March, pp. 33-37. Burnside, Craig, Eichenbaum, Martin, and Rebelo, Sergio (2007), “The Returns to the Curreny Speculation in Emerging Markets”, American Economic Review, Vol. , pp. 333-338.
• Cairns, John, Ho, Corrinne and McCauley, Robert (2007), “Exchange Rates and Global Volatility: Implications for Asia-Pacific Currencies”, BIS Quarterly Review, March, pp. 41-52.
• Darvas, Zsolt (2009), “Leveraged Carry Trade Portfolios”, Journal of Banking and Finance, Vol. 33, pp. 944-957.
• Dunis, Christian, and Miao, Jia (2007), “Trading Foreign Exchange Portfolios with Volatility Filters: The Carry Trade Model Revisited”, Applied Financial Economics, Vol. 17, pp. 249-255.
• Fong, Wai (2010), “A Stochastic Dominance Analysis of Yen Carry Trades”,
• Journal of Banking and Finance, Vol. 34, pp. 1237-1246.
• Galati, Gabriele, Heath, Alexandra and McGuire, Patrick (2007), “Evidence of
• Carry Trade Activity”, BIS Quarterly Review, September, pp. 27-41. Gynelberg, Jacob and Remolona, Eli (2007), “Risk in Carry Trades: A Look at
• Target Currencies in Asia and the Pacific”, BIS Quarterly Review, December, pp. 82. Hottori, Masamzumi and Shin, Hyun (2007), “The broad yen carry trade, Bank of
• Japan, Institute for Monetary and Economic Studies”, Discussion Paper No 2007- E-19.
• Jurek, Jakub (2008), “Crash-Neutral Currency Carry Trades”, Working Paper,
• Princeton University. La Marca, Massimiliano (2007), “The Carry Trade and Financial Fragility”, in
• Coping with Globalized Finance: Recent Challenges and Long-term Perspectives, Proceedings of United Nations Conference on Trade and Development, pp. 13-21. McGuire, Patrick and Upper, C. (2007), Detecting FX Carry Trades, BIS
• Quarterly Review, March, Bank of International Settlements. Moosa, Imad (2008), Risk and return in carry trade, Journal of Financial
• Transformation, Vol. 22, No. 3, 10-15. Moosa, Imad (2010) The Profitability of Carry Trade, Economia Internazionale, Vol. 63, pp. 261-380.
• Olmo, Jose and Pilbeam, Keith (2009) The Profitability of Carry Trades, Annals of Finance, 5, 231-241.
• Zukerman, Gregory and Pacelle, Mitchell (1999), Treasury Prices Fall as Hedge
• Funds Seek to Unwind, Yen Carry Trades, Wall Street Journal, June 14, 1.