100 per cent. Well explained. Aside from volatility, all leverage is a “carry trade”. Without FX exposure, leveraged investors borrow at X% to buy assets that they hope will appreciate by more than X%. Then you add in FX risk and it really gets fun. You are betting on stability. And as you say and as we all learned from Long Term Capital, when everyone wants or has to sell everything is correlated.
In lieu of liquidity/maturity mismatches, a strategy if it could have been implemented would have been to borrow long in Yen without margin call risk so as to be able to ride out the storms
I looked into setting up a yen bank account, which is now possible with new firms like Revolut. That would have been long yen and not leveraged. But it would have been negative carry - since I would have financed it with money from my US money market fund, I'd be giving up 5% interest in exchange for nothing and then hoping to switch back once the exchange rate moved. It seemed like a lot of effort for a small payoff. That's an example of how difficult it is to "long vol" or bet against carry. Your timing has to be exquisite.
We haven’t decided yet…but we think the carry regime still has time to run. We will try to provide metric for understanding where we are in the transition out to a regime
As a long-time derivative trader, event risk like 9/11, Covid shock, etc, pose problems that can be solved by benefitting from Federal Reserve actions via what used to be Eurodollar calls- Now SOFR. Downside SP Puts also, but skew and long-term upward SP trend makes these costly.
I think that's the fundamental problem...we can see these events coming...we know the carry structure of markets will lead to sharp corrections. but the cost of being long vol is so high that you have to get the timing very precise to benefit. I think nimble individual traders can (possibly) do this but I don't most 'normal' investors can and I don't think it can be done at scale by large institutions. the best I can come up with is identifying structural longs that you'd be happy to own more of at lower prices and have limits ready to add to positions during a carry crash. I did a bit of this in August
100 per cent. Well explained. Aside from volatility, all leverage is a “carry trade”. Without FX exposure, leveraged investors borrow at X% to buy assets that they hope will appreciate by more than X%. Then you add in FX risk and it really gets fun. You are betting on stability. And as you say and as we all learned from Long Term Capital, when everyone wants or has to sell everything is correlated.
In lieu of liquidity/maturity mismatches, a strategy if it could have been implemented would have been to borrow long in Yen without margin call risk so as to be able to ride out the storms
I looked into setting up a yen bank account, which is now possible with new firms like Revolut. That would have been long yen and not leveraged. But it would have been negative carry - since I would have financed it with money from my US money market fund, I'd be giving up 5% interest in exchange for nothing and then hoping to switch back once the exchange rate moved. It seemed like a lot of effort for a small payoff. That's an example of how difficult it is to "long vol" or bet against carry. Your timing has to be exquisite.
The idea was to borrow in yen. Not U.S.
I see, I thought you were looking for ways to profit on the carry unwind.
Awesome read as always professor! Just out of curiosity, will be new book be called “The fall of carry”? 😄
We haven’t decided yet…but we think the carry regime still has time to run. We will try to provide metric for understanding where we are in the transition out to a regime
Kevin,
Very interesting perspective on what's going on. I hope the new book does well. Jason.
Jason, thanks! much appreciated
Awesome! Can't wait for the new book!
Thanks David, much appreciated. I guess we really have to finish it now that I’ve told everyone! Thanks for reading
As a long-time derivative trader, event risk like 9/11, Covid shock, etc, pose problems that can be solved by benefitting from Federal Reserve actions via what used to be Eurodollar calls- Now SOFR. Downside SP Puts also, but skew and long-term upward SP trend makes these costly.
I think that's the fundamental problem...we can see these events coming...we know the carry structure of markets will lead to sharp corrections. but the cost of being long vol is so high that you have to get the timing very precise to benefit. I think nimble individual traders can (possibly) do this but I don't most 'normal' investors can and I don't think it can be done at scale by large institutions. the best I can come up with is identifying structural longs that you'd be happy to own more of at lower prices and have limits ready to add to positions during a carry crash. I did a bit of this in August