Hedge Fund Strategies

Hedge Fund Strategies
Problem Set: Backtesting the Carry Trade (Macro Strategies)
Prof. Andrea Frazzini

In this problem set, you backtest the currency carry trade using the data provided in the accompanying Excel spreadsheet. You can do the problem set using Excel or any other program of your choice. Please answer in the space provided (no more than three pages for questions 1-6).
1. For each month of the sample, rank the countries based on their interest rate (hint:
Excel has a function called “RANK(cell,range,1)”). Compute each country’s average rank (1=lowest interest rate, etc.). Which two countries have the lowest average rank, and which have the highest:
Most often “funding currency” (i.e. low interest-rate):
Second to most often funding currency:
Most often “investment currency” (i.e. high interest-rate):
Second to most often investment currency:

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Plot here the rank of the US over time:

2. Create positions for each currency, either $1 (long), $-1 (short), or 0 (flat). Do this by going short the three currencies with the lowest interest rate, and long the three with the highest interest rate. (Hint: you can use the Excel function “IF” twice, one inside the other: “ = IF( cell = 7 , 1 , 0) ) ”.
What is the average position in New Zealand:

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3. Compute the excess return on each position, and add these up to get the excess return of the entire portfolio in any month. Make sure to get the timing right. (Hint: use
SKEW and KURT, and annualize as in notes.)
What is the annualized average excess return of the portfolio:
What is the annualized standard deviation:
What is the skewness of monthly returns:
What is the (excess) kurtosis of monthly returns:
What is the annualized SR:

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Comment on these numbers:

4. For each currency, compute the trade