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The Carry Trade, Portfolio Diversification, and the Adjustment of the Japanese Yen

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  • Corinne Winters

Abstract

In this paper, the author considers whether fundamentals or other factors can explain the yen's ongoing weakness. In particular, the importance of capital outflows due to the carry trade and longer-term portfolio investment outflows, which may be delaying the adjustment of the yen, are investigated. A simple portfolio model is developed, composed of a speculative component and a minimum variance portfolio, to address the underlying motivation for capital outflows from Japan over the past ten years. The author's main findings suggest that a substantial portion of outflows may be attributed to diversification. Furthermore, given that considerable 'home bias' remains in Japanese households' portfolios, the results suggest that capital outflows from households, largely driven by diversification, may continue to dampen a long-run appreciation of the yen going forward. That said, evidence of substantial speculative outflows, through carry trades, complicates the outlook for the yen.

Suggested Citation

  • Corinne Winters, 2008. "The Carry Trade, Portfolio Diversification, and the Adjustment of the Japanese Yen," Discussion Papers 08-2, Bank of Canada.
    • Handle: RePEc:bca:bocadp:08-2
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    More about this item

    Keywords

    Exchange rates; International topics; Recent economic and financial developments;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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