Abstract

http://ssrn.com/abstract=2192817
 
 

Citations (2)



 


 



Carry Trade and Systemic Risk: Why are FX Options so Cheap?


Ricardo J. Caballero


Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Joseph B. Doyle


Cornerstone Research

December 2012

NBER Working Paper No. w18644

Abstract:     
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 beta-adjusted 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.

Number of Pages in PDF File: 45


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Date posted: December 22, 2012  

Suggested Citation

Caballero, Ricardo J. and Doyle, Joseph B., Carry Trade and Systemic Risk: Why are FX Options so Cheap? (December 2012). NBER Working Paper No. w18644. Available at SSRN: http://ssrn.com/abstract=2192817

Contact Information

Ricardo J. Caballero (Contact Author)
Massachusetts Institute of Technology (MIT) - Department of Economics ( email )
50 Memorial Drive
Building E52-528
Cambridge, MA 02142
United States
617-253-0489 (Phone)
617-253-1330 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Joseph B. Doyle
Cornerstone Research ( email )
699 Boylston St.
Boston, MA 02116
United States
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