CARRY TRADE STRATEGIES WITH FACTOR AUGMENTED MACRO FUNDAMENTALS: A DYNAMIC MARKOV-SWITCHING FACTOR MODEL

Gokcen Ogruk

The International Journal of Business and Finance Research, 2016, vol. 10, issue 3, 11-28

Abstract: This paper evaluates the performance of carry trade strategies with macro fundamentals in a Markov switching dynamic factor augmented regression framework and compares the performance statistics with the benchmark model of a random walk and momentum strategy. I make simulations with the Japanese Yen, Swiss Franc and US Dollar as funding currencies against six target currencies. Carry trade, a currency speculation strategy between the high-interest rate and low-interest rate currencies, generates high payoffs on average but has a possibility of crash risk. I argue that risk adjusted returns, mean returns and downside risk perform better when purchasing power parity model is used in a both regime switching and linear factor augmented regression framework for Franc trades and perform as good as benchmark model of momentum strategy for Dollar and Yen trades

Keywords: Exchange Rate Models; Carry Trade; Forecasting; Markov-Switching Dynamic Factor (search for similar items in EconPapers)
JEL-codes: C22 E32 E37 E43 F31 F37 G15 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:ibf:ijbfre:v:10:y:2016:i:3:p:11-28

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