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Quantitative modeling study reveals that foreign exchange volatility offsets yen carry trade returns despite dynamic hedging, highlighting the inherent instability of textbook currency arbitrage.
Borrow JPY at a low rate, invest in a higher-yield USD asset, and earn the difference. This is the crux of the yen carry trade. However, this entails a certain FX exposure (long USD and short JPY), and FX movements can overwhelm the carry. With a mathematical analysis and a backtest, this paper tests whether a dynamic hedge can suppress the currency risk. This paper's goal is to better understand why the textbook yen carry trade is, in reality, neither free nor stable income.
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Samuel Sprauel (2026) studied this question.
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