Carry Trade and Systemic Risk: Why are FX Options so Cheap?
In this paper we document first that, in contrast with their widely perceived excess returns, popular carry trade strategies yield low systemic-risk-adjusted returns. In particular, we show that carry trade returns are highly correlated with the return of a VIX rolldown strategy —i.e., the strategy...
| Main Authors: | , |
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| Format: | Working Paper |
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Cambridge, MA: Department of Economics, Massachusetts Institute of Technology
2013
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| Online Access: | http://hdl.handle.net/1721.1/76719 |
| _version_ | 1826190457055477760 |
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| author | Caballero, Ricardo Doyle, Joseph B. |
| author_facet | Caballero, Ricardo Doyle, Joseph B. |
| author_sort | Caballero, Ricardo |
| collection | MIT |
| description | In this paper we document first that, in contrast with their widely perceived excess returns, popular carry trade strategies yield low systemic-risk-adjusted returns. In particular, we show that carry trade returns are highly correlated with the return of a VIX rolldown strategy —i.e., the strategy of shorting VIX futures and rolling down its term structure— and that the latter strategy performs at least as well as betaadjusted carry trades, for individual currencies and diversified portfolios. In contrast, hedging the carry with exchange rate options produces large returns that are not a compensation for systemic risk. We show that this result stems from the fact that the corresponding portfolio of exchange rate options provides a cheap form of systemic insurance. |
| first_indexed | 2024-09-23T08:40:32Z |
| format | Working Paper |
| id | mit-1721.1/76719 |
| institution | Massachusetts Institute of Technology |
| last_indexed | 2024-09-23T08:40:32Z |
| publishDate | 2013 |
| publisher | Cambridge, MA: Department of Economics, Massachusetts Institute of Technology |
| record_format | dspace |
| spelling | mit-1721.1/767192019-04-09T19:07:32Z Carry Trade and Systemic Risk: Why are FX Options so Cheap? Caballero, Ricardo Doyle, Joseph B. Carry trade forward premium puzzle vix futures and rolldown interest parity condition Fama-French factors In this paper we document first that, in contrast with their widely perceived excess returns, popular carry trade strategies yield low systemic-risk-adjusted returns. In particular, we show that carry trade returns are highly correlated with the return of a VIX rolldown strategy —i.e., the strategy of shorting VIX futures and rolling down its term structure— and that the latter strategy performs at least as well as betaadjusted carry trades, for individual currencies and diversified portfolios. In contrast, hedging the carry with exchange rate options produces large returns that are not a compensation for systemic risk. We show that this result stems from the fact that the corresponding portfolio of exchange rate options provides a cheap form of systemic insurance. 2013-02-04T04:14:30Z 2013-02-04T04:14:30Z 2012-12-05 Working Paper http://hdl.handle.net/1721.1/76719 Working paper, Massachusetts Institute of Technology, Dept. of Economics;12-28 An error occurred on the license name. An error occurred getting the license - uri. application/pdf Cambridge, MA: Department of Economics, Massachusetts Institute of Technology |
| spellingShingle | Carry trade forward premium puzzle vix futures and rolldown interest parity condition Fama-French factors Caballero, Ricardo Doyle, Joseph B. Carry Trade and Systemic Risk: Why are FX Options so Cheap? |
| title | Carry Trade and Systemic Risk: Why are FX Options so Cheap? |
| title_full | Carry Trade and Systemic Risk: Why are FX Options so Cheap? |
| title_fullStr | Carry Trade and Systemic Risk: Why are FX Options so Cheap? |
| title_full_unstemmed | Carry Trade and Systemic Risk: Why are FX Options so Cheap? |
| title_short | Carry Trade and Systemic Risk: Why are FX Options so Cheap? |
| title_sort | carry trade and systemic risk why are fx options so cheap |
| topic | Carry trade forward premium puzzle vix futures and rolldown interest parity condition Fama-French factors |
| url | http://hdl.handle.net/1721.1/76719 |
| work_keys_str_mv | AT caballeroricardo carrytradeandsystemicriskwhyarefxoptionssocheap AT doylejosephb carrytradeandsystemicriskwhyarefxoptionssocheap |