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Reinvestigating The Uncovered Interest Rate Parity Puzzle Via Analysis Of Multivariate Tail Dependence In Currency Carry Trades
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Book Synopsis Reinvestigating the Uncovered Interest Rate Parity Puzzle Via Analysis of Multivariate Tail Dependence in Currency Carry Trades by : Matthew Ames
Download or read book Reinvestigating the Uncovered Interest Rate Parity Puzzle Via Analysis of Multivariate Tail Dependence in Currency Carry Trades written by Matthew Ames and published by . This book was released on 2014 with total page 26 pages. Available in PDF, EPUB and Kindle. Book excerpt: The currency carry trade is the investment strategy that involves selling low interest rate currencies in order to purchase higher interest rate currencies, thus profiting from the interest rate differentials. This is a well known financial puzzle to explain, since assuming foreign exchange risk is uninhibited and the markets have rational risk-neutral investors, then one would not expect profits from such strategies. That is uncovered interest rate parity (UIP), the parity condition in which exposure to foreign exchange risk, with unanticipated changes in exchange rates, should result in an outcome that changes in the exchange rate should offset the potential to profit from the interest rate differentials. Given foreign exchange market equilibrium, the interest rate parity condition implies that the expected return on domestic assets will equal the exchange rate-adjusted expected return on foreign currency assets.However, it has been shown empirically, that investors can actually earn profits by borrowing in a country with a lower interest rate, exchanging for foreign currency, and investing in a foreign country with a higher interest rate, whilst allowing for any losses (or gains) from exchanging back to their domestic currency at maturity. Therefore trading strategies that aim to exploit the interest rate differentials can be profitable on average. The intention of this paper is therefore to reinterpret the currency carry trade puzzle in light of heavy tailed marginal models coupled with multivariate tail dependence features. We analyse the returns of currency carry trade portfolios adjusting for tail dependence risk. To achieve this analysis of the multivariate extreme tail dependence we develop several parametric models and perform detailed model comparison. It is thus demonstrated that tail dependencies among specific sets of currencies provide other justifications to the carry trade excess return and also allow us to detect construction and unwinding periods of such carry portfolios.
Book Synopsis Violations of Uncovered Interest Rate Parity and International Exchange Rate Dependences by : Matthew Ames
Download or read book Violations of Uncovered Interest Rate Parity and International Exchange Rate Dependences written by Matthew Ames and published by . This book was released on 2015 with total page 34 pages. Available in PDF, EPUB and Kindle. Book excerpt: The uncovered interest rate parity puzzle questions the economic relation existing between short term interest rate differentials and exchange rates. One would indeed expect that the differential of interest rates between two countries should be offset by an opposite evolution of the exchange rate between them, hence ruling out any limited risk profit opportunities. However, it has been shown empirically that this relation is not holding and accordingly has led, over the past two decades, to the reinforcement of a well-known trading strategy in financial markets, namely the currency carry trade. This paper investigates how highly leveraged, mass speculator behaviour affects the dependence structure of currency returns. We propose a rigorous statistical modelling approach using two complementary techniques in order to demonstrate that speculative carry trade volumes are informative in both the covariance and tail dependence of high and low interest rate currency returns, whereas the price based factors previously suggested in the literature hold little explanatory power. We add a new feature to the understanding of the link between the UIP condition and the carry trade strategy, specifically attributed to the large joint exchange rate movements in high and low risk environments.The appendices for this paper are available at the following URL: "http://ssrn.com/abstract=2638103" http://ssrn.com/abstract=2638103.
Book Synopsis Fundamental Aspects of Operational Risk and Insurance Analytics by : Marcelo G. Cruz
Download or read book Fundamental Aspects of Operational Risk and Insurance Analytics written by Marcelo G. Cruz and published by John Wiley & Sons. This book was released on 2015-01-20 with total page 928 pages. Available in PDF, EPUB and Kindle. Book excerpt: A one-stop guide for the theories, applications, and statistical methodologies essential to operational risk Providing a complete overview of operational risk modeling and relevant insurance analytics, Fundamental Aspects of Operational Risk and Insurance Analytics: A Handbook of Operational Risk offers a systematic approach that covers the wide range of topics in this area. Written by a team of leading experts in the field, the handbook presents detailed coverage of the theories, applications, and models inherent in any discussion of the fundamentals of operational risk, with a primary focus on Basel II/III regulation, modeling dependence, estimation of risk models, and modeling the data elements. Fundamental Aspects of Operational Risk and Insurance Analytics: A Handbook of Operational Risk begins with coverage on the four data elements used in operational risk framework as well as processing risk taxonomy. The book then goes further in-depth into the key topics in operational risk measurement and insurance, for example diverse methods to estimate frequency and severity models. Finally, the book ends with sections on specific topics, such as scenario analysis; multifactor modeling; and dependence modeling. A unique companion with Advances in Heavy Tailed Risk Modeling: A Handbook of Operational Risk, the handbook also features: Discussions on internal loss data and key risk indicators, which are both fundamental for developing a risk-sensitive framework Guidelines for how operational risk can be inserted into a firm’s strategic decisions A model for stress tests of operational risk under the United States Comprehensive Capital Analysis and Review (CCAR) program A valuable reference for financial engineers, quantitative analysts, risk managers, and large-scale consultancy groups advising banks on their internal systems, the handbook is also useful for academics teaching postgraduate courses on the methodology of operational risk.
Book Synopsis Uncovered Interest Parity by : Mr.Peter Isard
Download or read book Uncovered Interest Parity written by Mr.Peter Isard and published by International Monetary Fund. This book was released on 1991-05 with total page 14 pages. Available in PDF, EPUB and Kindle. Book excerpt: This note provides an overview of the uncovered interest parity assumption. It traces the history of the interest parity concept, summarizes evidence on the empirical validity of uncovered interest parity, and discusses the implications for macroeconomic analysis. The uncovered interest parity assumption has been an important building block in multiperiod and continuous time models of open economies, and although its validity is strongly challenged by the empirical evidence, its retention in macroeconomic models is supported on pragmatic grounds, at least for the time being, by the lack of much empirical support for existing models of the exchange risk premium.
Book Synopsis An Online Appendix to by : Matthew Ames
Download or read book An Online Appendix to written by Matthew Ames and published by . This book was released on 2016 with total page 13 pages. Available in PDF, EPUB and Kindle. Book excerpt: This online appendix to "Violations of Uncovered Interest Rate Parity and International Exchange Rate Dependences" includes the copula density function for the Clayton-Frank-Gumbel mixture copula and the details for the likelihood based estimation of the multivariate currency basket log returns. Currency carry trade high and low interest rate baskets over time are shown. Further results for the copula parameter fits and associated dependence measures are then analysed. A description of the method used to calculate the confidence intervals for the covariance regression is given. Finally, the method used to interpolate the one month forward price curve is explained.The paper "Violations of Uncovered Interest Rate Parity and International Exchange Rate Dependences" to which these Appendices apply is available at the following URL: "http://ssrn.com/abstract=2638163" http://ssrn.com/abstract=2638163.
Book Synopsis Uncovered Interest Parity by : Peter Isard
Download or read book Uncovered Interest Parity written by Peter Isard and published by International Monetary Fund. This book was released on 2006-04 with total page 16 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper provides an overview of the uncovered interest parity assumption. It traces the history of the interest parity concept, summarizes evidence on the empirical validity of uncovered interest parity, and discusses different interpretations of the evidence and the implications for macroeconomic analysis. The uncovered interest parity assumption has been an important building block in multiperiod models of open economies, and although its validity is strongly challenged by the empirical evidence, at least at short time horizons, its retention in macroeconomic models is supported on pragmatic grounds by the lack of much empirical support for existing models of the exchange risk premium.
Book Synopsis Uncovered Interest Parity Puzzle by : Byung-Joo Lee
Download or read book Uncovered Interest Parity Puzzle written by Byung-Joo Lee and published by . This book was released on 2006 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper proposes a new explanationfor the UIP puzzle by analyzing a large number of cross-country bilateral exchange rates in two dimensions, cross-sectional and time-series. The exchange rates analyzed here includes a broad spectrum of developed and developing countries. The UIP relationship holds up well in cross-sectional analysis and the slope estimates remain largely between zero and one throughout the sample periods, with a few exceptions. There does not appear to be a well-publicized UIP puzzle for cross-sectional UIP. For time-series UIP, short-term (one month) UIP holds up well and UIP puzzle is largely confined to the key currencies. We introduce the key currency bias to explain the empirical failure of UIP in these cases. The key currency concept is a similar to the home bias for portfolio holdings. UIP seems to fail more often when a key currency is involved in the bilateral exchange rate relationship than when only non-key currencies are involved, especially when the key currency offers higher return on capital. This paper presents an empirical evidence for a state-dependent asymmetric response in exchange rate changes depending on the direction of the forward premium.
Book Synopsis Testing the Uncovered Interest Rate Parity on Carry Trades by : Sergej Rybalko
Download or read book Testing the Uncovered Interest Rate Parity on Carry Trades written by Sergej Rybalko and published by . This book was released on 2008 with total page 69 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Uncovered Interest Parity by : Alain P. Chaboud
Download or read book Uncovered Interest Parity written by Alain P. Chaboud and published by . This book was released on 2003 with total page 32 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Long-horizon Uncovered Interest Rate Parity by : Guy Meredith
Download or read book Long-horizon Uncovered Interest Rate Parity written by Guy Meredith and published by . This book was released on 1998 with total page 50 pages. Available in PDF, EPUB and Kindle. Book excerpt: Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements, although there is little consensus on why it fails. In contrast to previous studies, which have used relatively short-horizon data, we test UIP using interest rates on longer-maturity bonds for the G-7 countries. These long-horizon regressions yield much more support for UIP -- all the coefficients on interest differentials are of the correct sign, and almost all are closer to the UIP value of unity than to the zero coefficient implied by the random walk hypothesis. We then use a small macroeconomic model to explain the differences between the short- and long-horizon results. Regressions run on data generated by stochastic simulations replicate the important regularities in the actual data, including the sharp differences between short- and long-horizon parameters. In the short run from risk premium shocks in the face of endogenous monetary policy. In the long run, in contrast, exchange rate movements are driven by the "fundamentals," leading to a relationship between interest rates and exchange rates that is more consistent with UIP.
Book Synopsis The Uncovered Interest Rate Parity Puzzle in the Foreign Exchange Market by : Sahil Aggarwal
Download or read book The Uncovered Interest Rate Parity Puzzle in the Foreign Exchange Market written by Sahil Aggarwal and published by . This book was released on 2013 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Trading the Forward Rate Puzzle by : Momtchil Pojarliev
Download or read book Trading the Forward Rate Puzzle written by Momtchil Pojarliev and published by . This book was released on 2019 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: The general conclusion from academic literature is that, while covered interest rate parity holds, uncovered interest rate does not. This conclusion is the so called forward premium puzzle. The carry strategy is based on this puzzle. This article compares the performance of three carry trading strategies with performance data from currency managers. The results show that currency managers have only little exposure to carry trades and that the carry strategies are still generating profit. This suggests that currency managers should allocate more risk towards carry strategies. Sticking to the simplest rules might be best.
Book Synopsis The Carry Trade and Uncovered Interest Parity When Markets Are Incomplete by : Jack Y. Favilukis
Download or read book The Carry Trade and Uncovered Interest Parity When Markets Are Incomplete written by Jack Y. Favilukis and published by . This book was released on 2015 with total page 60 pages. Available in PDF, EPUB and Kindle. Book excerpt: Many of the leading models of the carry trade imply that, contrary to the empirical evidence, a country's currency depreciates in times of high consumption and output growth, a manifestation of the Backus and Smith (1993) puzzle. We propose a modification of these models to account for financial market incompleteness and show that such a modification can induce positive correlation between currency appreciation and consumption or output growth while, at the same time, helping resolve the Backus and Smith (1993) and Brandt, Cochrane and SantaClara (2006) puzzles. Furthermore, in many of the existing models, the assumed fundamental cross-country differences (output volatility, growth, and risk attitude) responsible for interest rate differentials also appear at odds with the data. We document that default risk and financial openness are strongly related to interest rate differentials and carry trade profits in the data. The incomplete markets model we propose is consistent with these novel empirical facts.
Book Synopsis Uncovered Interest Rate Parity by : Andreea Constantin
Download or read book Uncovered Interest Rate Parity written by Andreea Constantin and published by . This book was released on 2018 with total page 48 pages. Available in PDF, EPUB and Kindle. Book excerpt: The paper gives evidence of a novel pricing factor for the cross-section of carry trade returns based on trade relations between countries. In particular, we apply network theory on countries' bilateral trade to construct a measure for countries' exposure to a global trade risk. A high level of exposure to global trade risk implies that the economic activity in one country is highly dependent on the economic activity of its trade partners and on aggregate trade flow, which reflects in carry trade returns. We find empirically that low interest rate currencies are seen by investors as a hedge against global trade risk while high interest rate currencies deliver low returns when global trade risk is high. These results provide evidence on the underlying macroeconomic sources of systematic risk in currency markets.
Book Synopsis The Uncovered Interest Rate Parity - A Literature Review by : Hiruni Kaushala
Download or read book The Uncovered Interest Rate Parity - A Literature Review written by Hiruni Kaushala and published by . This book was released on 2016 with total page 14 pages. Available in PDF, EPUB and Kindle. Book excerpt: Interest rates and exchange rates are considered to be one of the most discussed areas in International Finance. When considering the main theories that explore on these two variables, Uncovered Interest Rate Parity (UIP) states that the interest rate differential is an unbiased predictor of the spot exchange rate changes. The impact on investors' attitude is that they would be indifferent towards the returns on domestic and foreign assets denominated in same currency thereby eliminating any short term arbitrage profits. Studies of this nature are of significance in the case of Sri Lanka, as a country which is trade dependent accurate forecasts of exchange rates would be of immense importance. Hence this study focuses on reviewing what is revealed by literature so far and what is not.
Book Synopsis Interest Rate Parity with Credit Risk by : Toby Im
Download or read book Interest Rate Parity with Credit Risk written by Toby Im and published by . This book was released on 2020 with total page 65 pages. Available in PDF, EPUB and Kindle. Book excerpt: The incredible profitability of the carry trade over the past six decades constitutes a puzzle for interest rate parity. Contrary to recent behavioral or friction based approaches that explain deviations from traditional interest rate parity, I examine the effect of foreign sovereign credit risk and associated sharp currency devaluations on interest rate parity. To ensure that the theoretical implications apply generally, the setting is a continuous time arbitrage pricing model driven by Levy processes. I derive the statements of covered and uncovered interest rate parity under credit risk. The model produces novel measures of sovereign credit risk and carry trade profitability - most notably, forward-implied default intensities and the difference of same-maturity futures and forward prices. Empirically, introducing credit risk into the statement of covered interest rate parity makes pricing errors vanish for Mexico and the G10 countries: The profitability of both the covered and uncovered carry trade are fully accounted for by a modest allowance for credit risk and currency devaluation. I find mixed results for a carry trade trading system whose long/short position is determined by an estimate of the risk neutral expected return to the carry trade.
Book Synopsis A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle by : Kuk Mo Jung
Download or read book A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle written by Kuk Mo Jung and published by . This book was released on 2015 with total page 34 pages. Available in PDF, EPUB and Kindle. Book excerpt: A new monetary theory is set out to resolve the "Uncovered Interest Parity (UIP)" Puzzle. It explores the possibility that liquidity properties of money and nominal bonds can account for the puzzle. A key concept in our model is that nominal bonds carry liquidity premia due to their medium of exchange role as either collateral or means of payment. In this framework no-arbitrage ensures a positive comovement of real return on money and nominal bonds. Thus, when inflation in one country becomes relatively lower, i.e., real return on this currency is relatively higher, its nominal bonds should also yield higher real return. We show that their nominal returns can also become higher under the economic environment where collateral pledgeability and/or liquidity of nominal bonds and/or collateralized credit based transactions are relatively bigger. Since a currency with lower inflation is expected to appreciate, the high interest currency does indeed appreciate in this case, i.e., the UIP puzzle is no longer an anomaly in our model. Our liquidity based theory can in fact help understanding many empirical observations that risk based explanations find difficult to reconcile with.
