A Machine Learning Approach to Forecasting Carry Trade Returns

Xiao Wang, Xiao Xie, Yihua Chen & Borui Zhao (2021) A machine learning approach to forecasting carry trade returns, Applied Economics Letters, https://doi.org/10.1080/13504851.2021.1918624

15 Pages Posted: 3 Nov 2020 Last revised: 4 Oct 2021

See all articles by Xiao Wang

Xiao Wang

University of Science and Technology of China

Xiao Xie

Shanghai Advanced Institute of Finance

Yihua Chen

affiliation not provided to SSRN

Borui Zhao

University of Science and Technology of China (USTC)

Date Written: August 23, 2020

Abstract

Carry trade refers to a risky arbitrage in interest rate differentials between two currencies. Persistent excess carry trade returns pose a challenge to foreign exchange market efficiency. Using a data set of ten currencies between 1990 and 2017, we find: (i) a machine learning model, long short-term memory (LSTM) networks, forecast carry trade returns better than linear and threshold regressions based on economic fundamentals; and (ii) excess carry trade returns deteriorate after the 2007--2008 global financial crisis in LSTM networks and other model forecasts, indicating that the uncovered interest rate parity may still hold in the long run.

Keywords: carry trade, uncovered interest rate parity, machine learning, long short-term memory networks

JEL Classification: C45, F21, F31, F37

Suggested Citation

Wang, Xiao and Xie, Xiao and Chen, Yihua and Zhao, Borui, A Machine Learning Approach to Forecasting Carry Trade Returns (August 23, 2020). Xiao Wang, Xiao Xie, Yihua Chen & Borui Zhao (2021) A machine learning approach to forecasting carry trade returns, Applied Economics Letters, https://doi.org/10.1080/13504851.2021.1918624, Available at SSRN: https://ssrn.com/abstract=3693780 or http://dx.doi.org/10.2139/ssrn.3693780

Xiao Wang (Contact Author)

University of Science and Technology of China ( email )

China

HOME PAGE: http://https://sites.google.com/site/xiaowangeconomics/

Xiao Xie

Shanghai Advanced Institute of Finance ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Yihua Chen

affiliation not provided to SSRN

Borui Zhao

University of Science and Technology of China (USTC) ( email )

96, Jinzhai Road
Hefei, Anhui 230026
China

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