Is Carry Trade Still Profitable in Turkish Lira?

Abstract

Carry trades are basically trades to take the advantage of high interest rates in one country by borrowing in a low interest country. The major risk in this type of financial investment is the currency risk. During the carry trade, the depreciation of the high interest rate currency against the low interest currency has to be avoided to protect carry trade profits, and even the principal investment. Anywhere between a small loss to a dramatic currency tail event loss is possible if not acted fast enough. Two complementary issues are examined. First one is to find out if there is an indicator that will signal the likelihood of the depreciation of the high interest rate currency (TRY) against the low interest currency (USD). REER is such an indicator signaling a possible depreciation whenever the value exceeds the important 100 level. The second part of the study focuses on the profitability of USD/TRY carry trade between 2005 and 2016 on a rolling months basis. The outcome as a whole shows positive results, but taken as two sample groups one sample covering 2005-2009, the other sample covering 2010-2016 the results are contradictory. First period is profitable while the second period produces a loss. Therefore the study concludes that USD/TRY as a carry trade is becoming increasingly less profitable despite the considerable interest rate difference between TRY and USD.