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

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  • Corinne Winters
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    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.

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    File URL: http://www.bankofcanada.ca/en/res/dp/2008/dp08-2.pdf
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    Bibliographic Info

    Paper provided by Bank of Canada in its series Discussion Papers with number 08-2.

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    Length: 33 pages
    Date of creation: 2008
    Date of revision:
    Handle: RePEc:bca:bocadp:08-2

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    Keywords: Exchange rates; International topics; Recent economic and financial developments;

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