The Unwinding Risk of the Japanese Carry Trade: Scenarios for Equity and Bond Markets

Rudolf Rudy?ar ()
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Rudolf Rudy?ar: Prague University of Economics and Business

No 15116864, Proceedings of Economics and Finance Conferences from International Institute of Social and Economic Sciences

Abstract: The Japanese yen-funded carry trade ? borrowing at Japan?s ultra-low interest rates to invest in higher-yield assets abroad ? has grown extensively in recent years, raising concerns about its potential unwinding. This paper examines the risk of a disorderly unwind of yen carry trades and the consequent impact on equity and bond markets, with a focus on U.S. equities. We synthesize insights from academic literature and central bank reports, and we deploy simulation models (VAR, Monte Carlo, and regression-based analyses) to explore scenario outcomes. Our analysis suggests that a sharp yen appreciation (triggered by either Japanese policy tightening or U.S. rate cuts) could force carry traders to liquidate positions, causing significant volatility in stock markets and a spike in risk aversion. Through scenario analysis, we find that the severity of market impact depends on the speed and scale of unwinding ? ranging from a mild normalization with limited market effects to a severe, rapid unwind that could resemble past crisis episodes. The results highlight the importance of monitoring carry trade-funded flows and ensuring market resilience to sudden reversals.

Keywords: Yen carry trade; Carry trade unwind; Equity markets; Bond markets; Interest rate differentials; Vector autoregression; Monte Carlo simulation; Safe-haven currency; Risk aversion; Capital flows (search for similar items in EconPapers)
Pages: 6 pages
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Published in Proceedings of the Proceedings of the International Conference on Economics, Finance & Business, London, Nov -0001, pages 205-210

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