Economic Policy Uncertainty and Carry Trade Strategy

Abstract

This study provides a comprehensive analysis of the impact of economic policy uncertainty on carry trade. Based on 24 countries (both emerging and developed markets) during the past 17 years, the paper considers five strategies of carry trade investment (i.e. positive carry, carry to risk, yield slope, policy change and valuation), three methods of portfolio constructions (equal weight, risk parity and mean variance optimization), and four types of economic policy uncertainties (US, Japan, EU and Global). Based on vector autoregressive model, it is found that US and Japan economic policy uncertainties have most impact on carry trade return. However, direction of such impact is ambiguous, depending on how carry trade portfolio have been formed. This is in contrast with the literature. Interestingly, the paper finds that carry trade strategy that focuses on emerging markets appears to be less sensitive to policy uncertainty shocks.