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The Impact of Currency Carry Trade Activity on the Transmission of Monetary Policy (Maximilian Boeck, Alina Steshkova, Thomas O. Zörner)

Author

Listed:
  • Maximilian Böck
  • Alina Steshkova

    (ViennaUniversity of Economics and Business)

  • Thomas Zörner

    (Oesterreichische Nationalbank (OeNB))

Abstract

This paper examines how carry trade activity affects the transmission of monetary policy in currency markets. It analyzes a set of developed and emerging market currencies against the U.S. dollar. The U.S. dollar appreciates in response to a conventional monetary policy shock but depreciates to a central bank information shock. A threshold vector autoregressive model is fitted to discriminate between different regimes of speculative carry trade activity. Higher carry trade intensity is associated with larger excess returns and higher crash risk. Across regimes, the differences in exchange rates are mild, while those in interest rates are more pronounced. A currency trading strategy created on the day of central bank announcements, which takes into consideration the joint co-movement of interest rates and stock prices, substantially outperforms the carry trade in terms of the Sharpe ratio and downside risk.

Suggested Citation

  • Maximilian Böck & Alina Steshkova & Thomas Zörner, 2024. "The Impact of Currency Carry Trade Activity on the Transmission of Monetary Policy (Maximilian Boeck, Alina Steshkova, Thomas O. Zörner)," Working Papers 258, Oesterreichische Nationalbank (Austrian Central Bank).
    • Handle: RePEc:onb:oenbwp:258
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    More about this item

    Keywords

    Currency markets; Carry Trade Strategy; Monetary Policy; Threshold VAR;
    All these keywords.

    JEL classification:

    • C24 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Truncated and Censored Models; Switching Regression Models; Threshold Regression Models
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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