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The Rand as a Carry Trade Target: Risk, Returns and Policy Implications

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  • Shakill Hassan
  • Sean Smith

Abstract

We analyze the returns to targeting the Australian, New Zealand, and South African currencies, through Japanese yen-funded speculation - with a particular focus on the South African rand, for which the carry trade is often seen as a source of exchange rate volatility. Targeting the rand through forward currency speculation produces returns which are as volatile, but with higher mean, and smaller probability of rare but large losses, than a buy-and-hold investment in the stock market - which is stochastically dominated in the second-order sense by the rand-targeting trade; and generates a larger return-to-volatility ratio than the Australian and New Zealand dollars - the two most common carry targets. Speculative positions and debt ‡ows driven by the carry trade cause an exchange rate process characterized by gradual appreciations punctuated by infrequent but potentially large and rapid depreciations. The consequent level of currency instability is a¤ected by whether in‡ows cause overheating, and how the central bank responds to the associated in‡ationary pressure

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Bibliographic Info

Paper provided by Economic Research Southern Africa in its series Working Papers with number 235.

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Length: 30 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:rza:wpaper:235

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Keywords: Currency speculation; carry trade; forward premium; skewness and crash risk; exchange rate instability; capital ‡ows;

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