TIME DIFFERENTIAL EFFECTS OF CREDIT YIELD SPREAD AND INTEREST RATE DIFFERENTIAL ON THE CURRENCY CARRY TRADE RETURN: THE CASE OF JAPANESE YEN

Minje Jung
Stephen M. Black
University of Central Oklahoma

ABSTRACT

The yen carry trade involves borrowing of yen at rates close to zero and selling the yen
(i.e., buying the dollar) to invest the proceeds in higher-yielding financial assets in U.S. The
authors calculated yen carry returns for1-month, 3-month, and 1-year investment horizons, and
examined the relationship between yen carry trade returns and two explanatory variables: the
interest rate differential between two currencies and Japanese risk aversion during the sample
period from October 2007 and August 2011. The authors of this study found that yen carry trades
were not profitable with negative returns for 1-month, 3-month, and 1-year investment horizons.
The interest rate differential between Japan and the U.S. were not large enough to compensate for
the increased carry trade risk due to the breakout and the lingering effect of the 2008 global
financial market crisis. The Japanese market-wide level of risk aversion (i.e., bond yield spread) is
found to be positively related to the yen carry trades.

Keywords: Yen carry trade, Uncovered Interest Parity, London Interbank Offered Rate