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The analysis of volatility transmission mechanism among carry trade currencies

Author

Listed:
  • Ekin TOKAT

    (TOBB Ekonomi ve Teknoloji Universitesi)

  • Atılım MURAT

    (TOBB Ekonomi ve Teknoloji Universitesi)

  • Hakkı Arda TOKAT

    (TOBB Ekonomi ve Teknoloji Universitesi)

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.

Suggested Citation

  • Ekin TOKAT & Atılım MURAT & Hakkı Arda TOKAT, 2014. "The analysis of volatility transmission mechanism among carry trade currencies," Iktisat Isletme ve Finans, Bilgesel Yayincilik, vol. 29(335), pages 23-44.
  • Handle: RePEc:iif:iifjrn:v:29:y:2014:i:335:p:23-44
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    More about this item

    Keywords

    Yen Carry Trade; Volatility Spillover; Multivariate GARCH; Asymmetric Shock.;

    JEL classification:

    • G19 - Financial Economics - - General Financial Markets - - - Other

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