International Academic Journal of Accounting and Financial Management

  • ISSN 2454-2350

The Effect of Considering Drift Factor on Carry Trade Profitability: A Case Study on GCC Currencies

Musaed S. AlAli and Yaser A. AlKulaib

Abstract: It has been well documented that carry trade is a profitable strategy specially when held for long periods. Literature have shown that such strategy can be very rewarding, matching the return of the S&P 500 and exceeding it in terms of the Sharpe ratio. Carry traders take advantage of interest rate differential between currencies by funding their investments in high yield currencies through borrowing low interest rate currencies. Since carry traders assume that exchange rates behave in a driftless manner, they enter such strategy based on interest rate differential as a sole selection criterion without considering the effect of changes in foreign exchange on their profitability. This paper examines the effect of considering statically significant drift in exchange rate on carry trade profitability if such criteria is embedded into the decision making process. Results from this paper show that taking statistically significant drift in exchange rate into the decision making process led to an improvement in both profitability and standers deviation resulting in an improvement in Sharpe ratio

Keywords: Carry trade, uncovered interest rate parity (UIP), Gulf Co-operation Council (GCC)

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Volume 1, Issue 1, 2014