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The Journal of Fixed Income

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Volatility and the Carry Trade

Vineer Bhansali
The Journal of Fixed Income Winter 2007, 17 (3) 72-84; DOI: https://doi.org/10.3905/jfi.2007.700219
Vineer Bhansali
An executive vice president, portfolio manager, and head of the Analytics Group at PIMCO in Newport Beach, CA.
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  • For correspondence: bhansali@pimco.com
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Abstract

The currency “carry trade”, in which an investor buys assets in a higher yielding currency by borrowing in a lower yielding currency, has been consistently exploited as a source of profits by investors. In this article, we discuss the effectiveness of the carry trade as prospective risk (measured by implied volatilities) in exchange rates varies. Based on simple equilibrium arguments we propose the hypothesis that the carry trade is effectively a form of short volatility trade. We also explore a simple strategy that combines carry with options and present a heuristic statistic for the measurement of the economics of the carry trade. We test the stratgy on actual historical carry and option price data and find that the hypothetical strategy allows for the presence of arbitrage opportunities between the forex option and carry markets.

TOPICS: Fixed income and structured finance, currency, options

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Volatility and the Carry Trade
Vineer Bhansali
The Journal of Fixed Income Dec 2007, 17 (3) 72-84; DOI: 10.3905/jfi.2007.700219

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Volatility and the Carry Trade
Vineer Bhansali
The Journal of Fixed Income Dec 2007, 17 (3) 72-84; DOI: 10.3905/jfi.2007.700219
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