The aim of this thesis is to investigate the dynamics of exchange rates for emerging markets (EM) taking into account their riskier nature from the viewpoint of foreign exchange investors. We use two different, albeit related, approaches to model the exchange rate. First, we revisit the forward bias puzzle under a setting where the global risk aversion plays a key role in the effect the forward premium has on the dynamics of the exchange rate. We argue that during low levels of risk aversion the high carry offered by EM attracts speculative capital which causes the currency to appreciated when, according to the UIP, one would have expected investors to demand a higher interest rate on currencies expected to fall. During high levels of risk aversion, investors pull their positions from the riskier economies, thus unwinding carry trades, which leads to the depreciation of the high-yielding currencies and we see deviations from UIP revert back to equilibrium. In the second approach, we investigate how well interest rate deviations from a Taylor-type rule explain returns to the carry trade, a currency trading strategy that takes advantage of the interest rate differential between countries, exposing itself only to the depreciation risk associated with the high-yielding currency. We argue that Central Banks take into account the exchange rate when setting the interest rate and thus may deviate from the policy rule in an attempt to influence the path of the exchange rate. These deviations, perceived as excess compensation for risk, make EM target currencies for carry trades increasing their demand and thus leading to their appreciation. This, in turn, implies large returns to carry trades since investors collect on top of the carry the exchange rate return as they transfer back the funds invested in the high-yielding currency. All in all, our findings based on both frameworks suggest that investors’ appetite for risk plays a key role, especially in the dynamics of the EM exchange rates.
| Identifer | oai:union.ndltd.org:bl.uk/oai:ethos.bl.uk:589851 |
| Date | January 2012 |
| Creators | Madeira, Ana R. F. |
| Publisher | University of Warwick |
| Source Sets | Ethos UK |
| Detected Language | English |
| Type | Electronic Thesis or Dissertation |
| Source | http://wrap.warwick.ac.uk/58552/ |
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