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The Economics and Finance Letters

February 2016, Volume 3, 2, pp 21-29

Forecasting-Based Carry Trade Using Pegged Currency: A Case of Omani Rial

Musaed S. AlAli

Musaed S. AlAli 1

  1. Department of Insurance and Banking, College of Business Studies, PAAET Safat, Kuwait 1

on Google Scholar
on PubMed

Pages: 21-29

DOI: 10.18488/journal.29/2016.3.2/29.2.21.29

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Abstract:

This paper examines the profitability of using an emerging country, currency that is pegged to the U.S. dollar in carry trade against floating currencies. It also examines the effect of embedding forecasting techniques in its profitability and risk-adjusted returns. While carry trade is performed largely with currencies that adapt a floating exchange rate system, conducting such a strategy using pegged currency has proven to be very rewarding, especially when the strategy is enhanced with forecasting methods. Carry trade is a speculative strategy where carry traders take advantage of interest rate differential between two currencies. It is conducted by borrowing a low interest rate currency and investing in a high interest rate currency. According to uncovered interest parity (UIP), carry trade should not yield any profit. If investors are both rational and risk-neutral, then exchange rate changes will eliminate any gains arising from the differential in interest rate. But literature has shown that UIP does not hold. This failure has led to unprecedented returns for that strategy matching the returns of the S&P 500 and outperforming it in terms of Sharpe ratio.

Contribution/ Originality
This study contributes to the existing literature on carry trade by examining the feasibility of using pegged currencies in such strategy. This study is one of the few studies which has investigated the effect of embedding forecasting methods in the selection process and its effect on return, risk and risk-adjusted returns.

Keywords:

Carry trade, Random walk, Uncovered interest parity (UIP), Omani rial (OMR), Monetary Model, Sharpe Ratio.

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Reference:

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Funding:

This study received no specific financial support.

Competing Interests:

The authors declare that they have no competing interests.

Acknowledgement:

I would like to express my gratitude to Prof. Imad Moosa from RMIT University for his gaudiness and unconditional support. I would also like to thank the anonymous referees for their thoughtful comments.

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