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US Dollar Carry Trades in the Era of ‘Cheap Money’

Last Updated on 10 February, 2024 by Rejaul Karim

In the pioneering research paper “US Dollar Carry Trades in the Era of ‘Cheap Money‘,” authored by Ali Shehadeh, Péter Erdős, Youwei Li, and Michael Moore, a groundbreaking investigation into the patterns of US dollar (USD) forward positions against various currencies in the context of the ultra-loose US monetary policy is unveiled.

Leveraging a unique dataset of USD forward positions taken by Commodity Trading Advisors (CTAs), the study delves into the extent to which these positions manifest USD carry trading or other currency trading patterns.

The analysis discerns that USD positions against emerging market currencies exhibit a distinctive pattern of carry trading, wherein the USD, as the lower yielding currency, is affiliated with short positions, underpinned by positive Sharpe ratios, negative skewness, and high kurtosis in the payoff distributions.

Conversely, USD positions against advanced country currencies portray a pattern consistent with uncovered interest parity trading, reflecting a paradigm shift in the dynamics of currency trading during the era of ‘cheap money.’

Abstract Of Paper

In this paper, we employ a unique dataset of actual US dollar (USD) forward positions against a number of currencies taken by so-called Commodity Trading Advisors (CTAs). We investigate to what extent these positions exhibit a pattern of USD carry trading or other patterns of currency trading over the recent period of the ultra-loose US monetary policy. Our analysis indeed shows that USD positions against emerging market currencies are characterised by a pattern of carry trading. That is, the USD, as the lower yielding currency, is associated with short positions. The payoff distributions of these positions, moreover, are found to have positive Sharpe ratios, negative skewness and high kurtosis. On the other hand, we find that USD positions against other advanced country currencies have a pattern completely opposite to carry trading which is in line with uncovered interest parity trading; that is, the lower (higher) yielding currency is associated with long (short) positions.

Original paper – Download PDF

Here you can download the PDF and original paper of US Dollar Carry Trades in the Era of ‘Cheap Money’.

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Author

Ali Shehadeh
University of Jordan

Péter Erdős
RPM Risk & Portfolio Management AB, Stockholm, Sweden

Youwei Li
Hull University Business School

Michael Moore
University of Warwick – Warwick Business School

Conclusion

The substantive insights unraveled in “US Dollar Carry Trades in the Era of ‘Cheap Money'” by Ali Shehadeh, Péter Erdős, Youwei Li, and Michael Moore provide a comprehensive elucidation of the intricate patterns underlying USD forward positions and their association with currency trading strategies amidst the ultra-loose US monetary policy.

The distinct pattern of carry trading observed in USD positions against emerging market currencies, characterized by short positions of the lower yielding currency and manifested in positive Sharpe ratios, negative skewness, and high kurtosis in the payoff distributions, underscores the transformative dynamics of USD carry trades in the era of ‘cheap money.’

Concurrently, the delineation of USD positions against advanced country currencies, aligning with uncovered interest parity trading, offers a glimpse into the evolving landscape of currency trading strategies.

This groundbreaking research not only unveils a transformative paradigm in currency trading but also enriches our understanding of the complex interplay between USD carry trades and the ultra-loose US monetary policy, making a substantive and innovative addition to the domain of financial economics.

Related Reading:

Global Currency Hedging with Common Risk Factors

Option-Implied Currency Risk Premia

FAQ

Q1: What is the main focus of the research paper “US Dollar Carry Trades in the Era of ‘Cheap Money'” by Ali Shehadeh, Péter Erdős, Youwei Li, and Michael Moore?

A1: The main focus of the research paper is the investigation of US dollar (USD) forward positions against various currencies, particularly in the context of the ultra-loose US monetary policy. The study aims to determine the extent to which these positions exhibit patterns of USD carry trading or other currency trading strategies.

Q2: What type of pattern is observed in USD positions against emerging market currencies, and what characteristics define this pattern?

A2: The analysis reveals that USD positions against emerging market currencies exhibit a distinctive pattern of carry trading. In this pattern, the USD, being the lower yielding currency, is associated with short positions. The payoff distributions of these positions are characterized by positive Sharpe ratios, negative skewness, and high kurtosis. This suggests a specific strategy of shorting the lower yielding USD in the context of emerging market currencies.

Q3: How do USD positions against advanced country currencies differ from those against emerging market currencies?

A3: USD positions against advanced country currencies exhibit a pattern that is opposite to carry trading and is in line with uncovered interest parity trading. In this context, the lower yielding currency is associated with long positions, while the higher yielding currency is associated with short positions. This difference in patterns highlights the diverse dynamics in USD trading strategies across different types of currencies.

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