Carry

Abstract

We apply the concept of carry, which has been studied almost exclusively in currency markets, to any asset. A security's expected return is decomposed into its "carry," an ex-ante and model-free characteristic, and its expected price appreciation. Carry predicts returns cross-sectionally and in time series for a host of different asset classes, including global equities, global bonds, commodities, US Treasuries, credit, and options. Carry is not explained by known predictors of returns from these asset classes, and it captures many of these predictors, providing a unifying framework for return predictability. We reject a generalized version of Uncovered Interest Parity and the Expectations Hypothesis in favor of models with varying risk premia, in which carry strategies are 6 We are grateful for helpful comments from John Y. Campbell (referee) as well as Cliff Asness, Jules van

The Term Structure of Systematic and Idiosyncratic Risk

“…From an asset pricing standpoint, our findings imply, though do not directly test, that the cross-sectional strategies of Vasquez (2016) and Koijen et al (2017) mainly sort on the expected path of the future short-term option implied volatility, rather than a related term premium. Thus, our results suggest that these studies capture a risk premium associated with cross-sectional differences in expectations about future short-term risk.…”

“…For example, Vasquez (2016) and Koijen et al (2017) document that the spread between option prices of different maturities predicts future option returns. At the same time, security exchanges are increasingly disseminating information about the term structure of option implied volatility and correlation.…”

Basis‐Momentum

“…Koijen et al. () show that transaction costs subsume only a small part of the returns to basis strategies. Given that basis and momentum strategies are already applied in practice and are not too different in stability and composition from basis‐momentum, it is unlikely that transaction costs subsume the large basis‐momentum returns.…”

Speculative pressure

“…Bessembinder () finds that residual risk conditioned on net hedging or speculative positions has strong cross‐sectional explanatory power for agricultural and currency futures returns, while Moskowitz et al () document a relatively weak nexus between net speculative positions and time‐series momentum in fixed income futures markets. In a different vein, the carry study across futures markets in Koijen et al () also documents weaker results for fixed income instruments.…”

“…A positive CER implies that the portfolio is more attractive than the risk-free asset. 8 Following Koijen et al (2018, we adjust the fixed income and interest rate futures returns by the duration of the underlying security to ensure that the results are not duration-distorted. Thus, futures with higher (lower) durations are scaled-down (up) in the long-short speculative pressure portfolio.…”