Global Asset Market Interdependencies : A Dynamic Interaction

Currency carry trading presents a widespread trading strategy and refers to the forward premium puzzle. Investors borrow low-yielding currencies with the aim to invest in high-yielding ones in order to benefit from arbitrage opportunities. This implies that a one-to-one relationship does not exist between interest rate differentials and expected changes in exchange rates. On this basis, we explore the interaction between currency carry trade, futures, exchange rates, and commodities through structural shocks. Investors desire a higher risk premium for interest differentials. Therefore, spillovers to prices of futures contracts and an appreciation of exchange rates are in line with the forward premium puzzle. Findings support that currencies with higher interest rates appreciate more often than currencies with lower rates. Furthermore, commodity prices and currency carry trading have a mutual impact due to monetary policy implications as well as real interest rate expectations. However, a simple relationship does not exist and the interconnection is complex in nature