CBR Briefing #3

• “Carry”—an asset’s expected return assuming its price remains the same—is useful far beyond its traditional domain of currency trading, and can help investors link return predictors across different asset classes, according to research by Chicago Booth’s Tobias J. Moskowitz, Ralph S.J. Koijen of the London School of Economics, NYU’s Lasse H. Pedersen, and VU University of Amsterdam’s Evert B. Vrugt.
• Carry predicts future price appreciation across a range of financial markets. Bond carry is related to the slope of the yield curve, commodity carry to the “convenience yield” (the benefit of holding the underlying physical good), and equity carry to a forward-looking measure of dividends.
• Investors can use carry as a framework to compare return predictors, such as dividend yields and bond coupons, which researchers had previously thought were difficult to weigh against each other.
• A “zero-cost carry trade portfolio”—buying high-carry securities and selling low-carry ones—captures a significantly better risk-adjusted return within each asset class than other asset-pricing models.
• A portfolio that combines carry trades on all assets improves risk-adjusted returns even more than carry trades on individual assets, including currencies, suggesting sizeable benefits from diversification (see chart).

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