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Contribution Details

Type Master's Thesis
Scope Discipline-based scholarship
Title Commodity prices as a signal for currency carry trades
Organization Unit
  • Michel Alain Guillet
  • Thorsten Hens
  • Alexander Thoma
  • English
Institution University of Zurich
Faculty Faculty of Business, Economics and Informatics
Number of Pages 57
Date December 2016
Zusammenfassung Buying high-yielding currencies and short-selling low-yielding currencies has been a pro table strategy for many decades. In average the so called currency carry trades have been successful because the cross-country yield di erentials are not o -set by future spot rates. This contradicts the theory of uncovered interest rate parity and is known as the forward premium puzzle. Up until now investors have mainly focused on the yield spreads as a selection criterion for a currency carry trade strategy. Within this Master`s thesis a new signal, focusing on movements of future spot rates, is presented. As a forecast instrument for foreign exchange rate movements new commodity price indices are introduced. The indices are designed to represent the change in export revenues in every country and therefore, the underlying commodity prices are weighted according to its share in total exports of the respective country. An increase in the underlying commodity prices leads to an increase in export revenues and as a consequence, of a higher supply of foreign exchange, to an appreciation of the currency in the exporting country. Panel data of 24 countries from January 2000 until July 2016 is used for the analysis. The xed e ect regression indicates a signi cant correlation of the country-speci c commodity export price index and future foreign exchange rate changes. The e ect is signi cant on the 99% con dence level for a prediction period of one day, one week and one month. As a consequence, commodity prices have proved to be drivers of exchange rates movements and therefore can add value to a currency carry trade strategy set-up. Four currency carry trade strategies with di erent approaches are tested in the thesis. The rst strategy buys or short sells a forward of a country against the US dollar depending on the crosscountry interest rate di erential. The forward is bought if it is traded on a premium over the current spot rate and is sold short if traded at a discount. When investing in all country pairs with equal weights the risk-adjusted returns are in the range of equity indices. A short-long strategy based on a ranking model is used as the second strategy. Forwards are ranked by yield spreads and the top three are bought, while the bottom three are sold short. In the backtest the strategy yields an annualized Sharpe ratio of 1.31, primarily driven by returns before 2008. The third strategy is able to translate an averaging down approach, originating from equity investing into a currency carry trade set-up. An increase of the yield spread, beyond a certain threshold, leads to an additional buy or sell signal. As a result the average forward premiums and forward discounts an investor holds is increasing. An additional e ect is that exposure increases, whenever an investment opportunity arises. With an average leverage of 150.5% this approach results in the highest annualized return of all tested strategies, however exhibits a lower Sharpe ratio of 1.01. The last strategy is combining the research on the country-speci c commodity export price index with the currency carry trades. Reasoning that currency carry trades are only a combination of interest and foreign exchange rates, the last strategy uses two signals for every component. Based on the second strategy using a ranking model according to yield spread di erentials, the countryspeci c commodity export price indices as a predictor for foreign exchange rates are implemented. As a result the strategy yields less volatility on the expenses of return, resulting in a Sharpe ratio of 1.30
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