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Contribution Details

Type Master Thesis
Scope Discipline-based scholarship
Title Emerging Market Monetary Policy and the Carry Trade
Organization Unit
  • Rasia Naidoo
  • Thorsten Hens
  • English
Institution University of Zurich
Faculty Faculty of Business, Economics and Informatics
Number of Pages 48
Date November 2017
Abstract Text Previous Currency Carry Trade (CCT) studies have looked at short-term trades, which are rebalanced every month. In this paper, we build on the claim that duration is a significant factor in CCT strategies. Given that duration risk is directly linked to monetary policy, we examine the predictability of monetary policy decisions in a selection of emerging markets. We focus on the Taylor rule (1993) as a monetary policy response, which became a popular tool for implementing an inflation targeting framework following the emerging market crisis of the 1990s. We examine the Taylor fundamentals for ten emerging market inflation-targeting countries using a Vector Autoregression and Forecast Combination framework. We assess the accuracy of interest rate predictions using dynamic regressions on the Taylor fundamental variables. Finally, we use these results to develop a Duration Carry Trade strategy, by predicting future interest rate changes. We use these signals to determine the duration of the carry instrument to invest in. The Duration Carry Trade strategy yields slightly higher returns, on average, compared to a simple CCT strategy, and a positive Sharpe Ratio. However, the returns are not statistically significant and the volatility of returns is approximately 50% higher than the benchmark.
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