Friday, November 13, 2009

Don't get carried away with carry trading

FT Alphaville carries a warning about those looking for easy pickin's in the carry trade patch.

The warning: if you look only at the nominal value of rate differentials without the implied volatility behind the differential you are ignoring the risk part of the trade, to you're peril.
Whatever the incentives from the rate differentials, implied volatilities remain high enough to discourage carry trades. In both cases, the incentives are not only well below the peak, they are well below the average.

In other words, it’s only when volatility diminishes that we will really begin to see the instigation of the “mother of all carry trades“. Be warned.

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