The surge in inbound investments into rupee bonds was largely driven by
carry trades, adding to fears of a quick reversal in flows if the drop in rupee is not checked.
2014: Crash-neutral currency
carry trades. Journal of Financial Economics 113: 325-347.
"
Carry trades are notorious for risk-off unwinds, especially when positioning is crowded and correlated", and according to B of A's Emerging Market Carry-Sentiment Indicator (we swear, there is an Index or Indicator for everything these days), we are fast approaching the levels that historically have preceded a major correction.
(2009) argues that bouts of global risk aversion could trigger funding constraints through higher margins and capital requirements, associated with unwinding of
carry trades. Consistent with the literature on uncertainty shocks (Bloom, 2009), it was ordered first in the estimated VAR's under the Cholesky identification scheme.
According to Colavecchio (2008),
carry trades tend to be pursued only when the interest differential is wide enough to compensate for the foreign exchange risk being taken, and she confirms that an increase in exchange rate volatility and a decrease in expected interest rate differentials lead to a higher probability of
carry trade unwinding.
"We can't say for sure whether this policy will lead to a yen
carry trade and flooding in cheap foreign funds (on the local markets) because there are a lot of stages that such a policy has to go through before leading to actual
carry trades," a senior official at the Bank of Korea said.
Currency investors are rethinking
carry trades, a popular strategy in which investors borrow in a currency with low interest rates and buy a currency with high interest rates, according to the Wall Street Journal.
As in all of our work, here we consider a carry-trade strategy that combines individual-currency
carry trades into an equally-weighted portfolio.
The bank said that it was considering action against activities such as
carry trades that involve its short-term deposits that pay more than longer-dated government debt.
In
carry trades, traders borrow (sell) a low interest rate currency and lend (buy) a high interest rate currency.
That would enhance the yen's appeal as a funding currency of choice amongst investors like hedge funds and model funds, which are increasingly looking to sell the yen and buy high-yielding currencies, called
carry trades.
These low rates have set the stage for the mother of all "
carry trades."
