TY - JOUR T1 - Volatility and the Carry Trade JF - The Journal of Fixed Income SP - 72 LP - 84 DO - 10.3905/jfi.2007.700219 VL - 17 IS - 3 AU - Vineer Bhansali Y1 - 2007/12/31 UR - https://pm-research.com/content/17/3/72.abstract N2 - 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 ER -