Carry Trade Returns and Commodity Prices under Capital and Interest Rate Controls: Empirical Evidence from China

Lei Pan, Svetlana aslyuk-Escobedo and Vinod Mishra

No 16-18, Monash Economics Working Papers from Monash University, Department of Economics

Abstract: This paper examines the relationship between returns of carry trade and prices of commodity based collateral assets (aluminium, copper and gold) for the classical carry trade pair: U.S. Dollar and Chinese Yuan. Given the nature of the time series employed, we consider the presence of structural breaks for the empirical analysis. The Autoregressive Distributed lag (ARDL) model suggests that in the long run adding copper and gold in the carry trade portfolio reduces the standard deviation. Furthermore, the short-run dynamics only exist between gold price and returns of carry trade. Our causality results reveal that multi-horizon causality testing does uncover important information with respect to the dynamic interaction among carry trade returns and different commodity prices. In particular, we _nd a causal chain through copper price and broken causal chains between prices of aluminium and copper to carry trade returns (transmitted via gold price). We also use a structural VAR model to disentangle the underlying causes of gold price shocks. We show that close to 60% of the variation in the real price of gold can be attributed to structural shocks in the currency market.

Keywords: Carry trade; Commodity prices; Structural breaks; multiple horizon causality; Structural VAR (search for similar items in EconPapers)
Pages: 49 pages
Date: 2019-06
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