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Contribution Details

Type Master's Thesis
Scope Discipline-based scholarship
Title Value Equities in Carry Currencies
Organization Unit
  • Thormas Karg
  • Thorsten Hens
  • Tim Glaus
  • English
Institution University of Zurich
Faculty Faculty of Business, Economics and Informatics
Number of Pages 33
Date December 2016
Zusammenfassung This thesis aims to tackle and combine return characteristics of two prominent market anomalies: The equity value premium and the currency carry or "forward premium puzzle". The value premium refers to the regularity with which stocks with low valuation measures, such as book-to-market ratio, have outperformed the US and global equity markets. The currency carry refers to the empirical observation that buying currencies of high interest rate countries has led to high risk-adjusted returns in the past. This is based on the "forward premium puzzle" first introduced by Fama (1984). They found that despite academic theory suggests that a yield advantage from interest rates should be offset by future currency depreciation, this does not hold empirically. The objective of this thesis is to investigate the effect of interest rate environments on international stock returns, by combining a currency carry with an equity value strategy. The objective is to complement current literature by adding an equity component to the carry country selection and investigate resulting risk-return characteristics. In order to assess the proposed strategy, the investment universe is divided into two sub- samples of countries, consisting of developed and emerging market countries. The strategy is tested from 1994 through 2014(developed markets) and from 2001 to 2014 (emerging markets). First a top down analysis to receive the countries and currencies in which to invest is conducted. The only indicator being used is the interest rate differential based on the 3-month libor. The examined currencies are ranked according to these differentials. Then the highest differentials will be bought. Due to the combination with a long only equity strategy later, the strategy will not include short leg of a typical carry trade. In line with literature, a fixed weighting of the currencies will be applied. In a second step, the combination of the carry strategy with the stock value strategy will be done. For the stock value strategy a bottom up selection is conducted to sort the stocks according to their book to market ratio. The strategy invests in the stocks with the highest book to market ratio of a country’s stock exchange, selected previously by the carry strategy. Then the currency and stock returns from the constructed portfolios are being evaluated. Furthermore, risk and performance is assessed and a comparison to the standard currency carry is drawn. Combining an equity value strategy with a carry currency selection results in mean returns of up to 6.3% and sharpe ratios of up to 1.77 respectively. Absolute as well as risk adjusted returns are well above the corresponding equity benchmark, the S&P global 1200. The additional selection of countries and currencies based on interest rate differential has negative effects on the value performance and leads to an increase in volatility for the combined strategy. Furthermore the results suggest that a larger number of assets in both value and currency selection results in more favorable return characteristics (higher returns, more positive skew and higher kurtosis). In line with currency carry studies of Jordà and Taylor (2012) and Nozaki (2010), the combination of value and currency selected returns can enhance the performance in certain periods. Periods characterized by high returns are driven by an increase in spot returns and therefore increasing upside potential from both equity and spot returns. The positive returns obtained from the currency carry analysis of the sample also indicate that the premium puzzle continues to exist. An interesting extension of the analysis covered in this thesis would be to see how large the currency effects are, dependent on industry or import/ export exposure of a company respectively.
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