The analysis of volatility transmission mechanism among carry trade currencies

Ekin Tokat, Atılım Murat and Hakkı Arda Tokat
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Ekin Tokat: TOBB Ekonomi ve Teknoloji Universitesi
Atılım Murat: TOBB Ekonomi ve Teknoloji Universitesi
Hakkı Arda Tokat: TOBB Ekonomi ve Teknoloji Universitesi

Iktisat Isletme ve Finans, 2014, vol. 29, issue 335, 23-44

Abstract: Investors take the advantage of disequilibrium in spot and forward exchange markets by investing in higher yield currency on a covered basis. An alternative of covered interest arbitrage is uncovered interest arbitrage (UIA) in which investors choose to remain uncovered accepting the currency risk. The “yen carry trade” is known as a Longstanding application of UIA. Owing to Japanese low interest rates, yen carry trade has been a highly profitable strategy which involves borrowing in yen to buy higher yielding assets. Employing multivariate GARCH modeling, we examine the volatility transmission mechanism between the exchange rates involved in “yen carry trade”. Due to high impact of Lehman Brothers’ collapse on world financial markets, we rather do the analysis for both before and after the default. Results reveal that interactions between the exchange rates increase considerably in response to negative market shocks. Our findings present new cross-hedging opportunities for investors.

Keywords: Yen Carry Trade; Volatility Spillover; Multivariate GARCH; Asymmetric Shock. (search for similar items in EconPapers)
JEL-codes: G19 (search for similar items in EconPapers)
Date: 2014
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