The Impact Of RMB Carry Trade On China’s Financial Market

Carry trade is an international financial trading strategy based on the interest rate spread between two countries to build a cross-border portfolio.By influencing the level of liquidity and risk premium of asset prices in a country,carry trades can have an impact on a country’s financial market,causing financial market disturbances and even inducing financial risks.In recent years,RMB carry trades have been active and have caused fluctuations in China’s financial market to a certain extent;however,due to the diverse channels,hidden ways and difficult to estimate the scale of RMB carry trades,it is difficult to accurately assess the impact of carry trades on China’s financial market.In order to accurately portray the carry behavior in the economy and assess its impact on the financial market,this paper identifies the weights of the carry traders in the RMB foreign exchange market based on the heterogeneous subject theory,which reflects the active degree of carry trading in the economy.Further combined with the analysis of the mechanism of hedging transactions affecting China’s financial market,a TVP-VAR model including hedgers’ weights,short-term capital flows and financial market variables is constructed to examine the time-varying shock effects of changes in hedgers’ weights on China’s financial market,with a view to providing an empirical reference for the central bank to monitor hedging behavior in the economy and judge its impact.This paper first introduces a method to measure the weights of carry traders based on the theory of heterogeneous subjects in the foreign exchange market,and combats the carry phenomenon in China’s economy with the potential mechanism of carry trading affecting China’s financial market.Secondly,the time-varying weights of RMB carry traders are measured by applying RMB NDF data,based on the heterogeneous expectations model of RMB exchange rate and nonlinear least squares method.Further,a TVP-VAR model containing hedger weights,short-term capital flows,stock market price indices and commodity futures price indices is constructed in conjunction with China’s carry trade practice,focusing on the impact of hedger weight changes on China’s stock market and commodity futures market through interval impulse response function and time-point impulse response function.The main findings of this paper are as follows: the measurement of carry traders’ weights indicates that there was active RMB carried interest trading in the foreign exchange market between December 2010 and April 2015;after the "8.11 exchange reform" in 2015,the activity of carried interest traders diminished.The analysis based on the TVP-VAR model shows that the increase in the weight of RMB carry traders,i.e.,the increase in the activity of carry-rate trading,has a significant positive shock effect on both China’s stock market and commodity futures market yields in the short term(1 month),but the shock effect on both yields in the medium term(6 months)is smaller in the stock market;this indicates that carry-rate trading only has a short term shock effect on China’s financial markets.The analysis of time-point impulse responses shows that the shock effect of carry trades on stock market and commodity futures market yields is more dramatic at the point when the exchange rate risk increases and the weight of carry traders decreases rapidly,indicating that rapid changes in carry trade activity can form a large disturbance to the financial market.The robustness test of applying the hedge excess return to replace the hedger weight further validates the above findings.The conclusion of this paper suggests that RMB carry trade can impact China’s financial market,so China’s central bank should monitor the carry trade in the economy.During the period of unusually active carry trades,macro-prudential policies should be adopted to prevent the financial risks arising from carry trades.