Evaluating the East African currency carry trade

Abstract

This paper seeks to uncover the nature and diversification benefit of the East African Currency Carry Trade and its sensitivity to global financial system shocks on KESRWF, KESUGX and KESTZS currency pairs as well as the diversification benefit of the strategy to Kenyan equities. To do so, the study employs a Carry trade returns model to compute returns and Fixed-Effects model to estimate sensitivity of returns to global risk factors and employs Mean-Variance optimization to determine optimal portfolio weights. The study finds that the carry trade done on these currencies does sufficiently diversify the NSE 20 Index, and use of Mean-Variance optimisation improves risk-adjusted returns compared to an equal-weight portfolio. Furthermore, the East African Currency Carry trade is insulated from global risk factors, which are proxied by VIX Futures and the TED Spread.