The Profitability of Using Pegged Currencies in Carry Trade: A Case of Saudi Riyal

Abstract

This paper examines the profitability of using pegged currencies in carry trade. Conducting this exercise on Saudi riyal against six floating currencies has proven to be very rewarding especially when enhanced with forecasting methods. Carry trade is a very popular currency speculation strategy among traders, where they borrow low-interest currencies and invest in high-interest currencies. It is a strategy that takes advantage of interest rate differentials between two currencies. Such strategy should not work under uncovered interest parity (UIP), since according to UIP high interest rate currencies should depreciate against low interest rate currencies by the interest rate differential itself. But studies have shown that UIP does not stand and carry traders are profiting from it. As a result of its failure, carry traders are making returns matching the returns of the S&P 500 and outperforming it in terms of the Sharpe ratio.