Helsinki School of Economics, 18 November 2008.
Executive Summary of “Arbitrage Capital and Currency Carry Trade Returns”
A new HSE working paper by professor Matti Suominen and two researchers Petri Jylhä and Jussi-Pekka Lyytinen, presents new evidence on the effects of the so called currency carry trades: that is, trades where investors borrow in low interest rate currencies and invest the proceeds in high interest rate currencies.
Their paper, to be presented at the American Finance Association meetings in San Francisco in January 2009, shows, using regression analysis, that carry trading is a main strategy for hedge funds. According to their results, the assets under management in hedge funds have in recent years grown so large that the hedge funds’ carry trade activity has had a statistically significant effect on interest and currency rates across the world. Due to the increase in capital devoted to currency carry trading, the high interest rate currencies (carry long currencies) have during the past several years appreciated and low interest rate currencies (carry trade short currencies) have depreciated. Because of this, the expected returns to carry trades, which according to their estimates were highly positive until the recent years, have been decreasing over time.
Right now, in contrast, there is a large ongoing outflow of capital from hedge funds, and thus a large unwinding of the currency carry trades. This has in the past two months been associated with a large appreciation of Japanese yen, US dollar and Swiss franc and a large depreciation of euro, Canadian dollar and British pound, in relation to most other currencies. The magnitude of these currency changes has been extraordinary: For instance, during a 30 day period until late October Japanese yen appreciated by more than 30% against the euro. These recent currency movements are consistent with their paper, as currently according to their results, yen, US dollar and Swiss franc are carry trade short currencies and euro, Canadian dollar and British pound are carry trade long currencies.
The entire research paper can be found using the following link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1113812 . A power point presentation of it is available by request from Matti Suominen.
About the authors:
Matti Suominen is a Professor of Finance at the Helsinki School of Economics. Petri Jylhä is a graduate student at the Helsinki School of Economics. Jussi-Pekka Lyytinen is a former masters-student from the Helsinki School of Economics, who works currently in currency trading at Pohjola Bank.