The Rand as a Carry Trade Target Risk Returns and Policy Implications

We analyze the returns to targeting the Australian, New Zealand and South African currencies, through Japanese yen-funded forward market speculation with a particular focus on the South African rand. Targeting the rand through forward currency speculation generates returns which are as volatile, but with higher mean, and smaller probability of rare but large losses, than a buy-and-hold investment in the stock market which is stochastically dominated in the second-order sense by the rand-targeting trade; and a larger return-tovolatility ratio than the Australian and New Zealand dollars the most common carry targets. Foreign-exchange market turnover and debt flows driven by the carry trade cause gradual appreciations punctuated by infrequent but potentially large and rapid depreciations. The consequent level of currency instability is affected by whether inflows cause overheating, and how the central bank responds to the associated inflationary pressure. Reducing short-term rand volatility however, is likely to increase its allure as a carry target.