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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

Suggested Citation

  • Shakill Hassan & Sean Smith, 2011. "The Rand as a Carry Trade Target: Risk, Returns and Policy Implications," Working Papers 235, Economic Research Southern Africa.
  • Handle: RePEc:rza:wpaper:235
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    File URL: http://www.econrsa.org/node/258
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    References listed on IDEAS

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    Cited by:

    1. Narayan, Paresh Kumar & Mishra, Sagarika & Narayan, Seema & Thuraisamy, Kannan, 2015. "Is Exchange Rate Trading Profitable?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 38(C), pages 217-229.

    More about this item

    Keywords

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

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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