Determinants of Carrying Trade with Indian Rupee: Variables and Methods

Abstract

We have taken six variables to ascertain their contribution in finding the direction and values of carry trade returns in Indian rupee. These variables are as follows: foreign exchange volatility; interest rate difference; volatility in equity market; interest rate difference volatility; liquidity in foreign exchange and commodity index. We have employed three methods—ordinary least square, multivariate adaptive regression splines (MARS) and autoregressive integrated moving average (ARIMA-X) to find the predictive capacity of these above-mentioned variables. We find that interest rate differential and volatility in equity market significantly affect carry trade returns with spot exchange rates. Thus, traders can take the indication from volatility in equity market and interest rate difference for the return of carry trade returns.