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Yen Carry Trade and the Subprime Crisis

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Abstract

Yen carry trades have traditionally been viewed in narrow terms purely as a foreign exchange transaction. This paper argues that the carry trade should instead be viewed in the broader context of global credit conditions. We show that the volume of yen funding that is channeled for use outside Japan is mirrored by fluctuations in the size of U.S. broker-dealer balance sheets. Differences in short-term interest rates across currencies help to explain the incidence of the carry trade, as does the measure of implied equity risk given by the VIX index. The conjunction of deteriorating credit conditions in the United States and the weakness of the dollar against the yen in the early stages of the credit crisis of 2007–08 can thus be seen as two sides of the same coin. Both can be seen as consequences of financial sector deleveraging in the United States.

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Notes

  1. “Debt Reckoning: US Receives a Margin Call,” Wall Street Journal, March 14, 2008.

  2. See Brunnermeier (2008); BIS (2008); IMF (2008); and Greenlaw and others (2008) for a chronology of the credit crisis of 2007–08.

  3. The index is available at www.markit.com.

  4. See Shin (2008) for the details of the analysis.

  5. The Japan premium explains the very sharp spike upward in the “bills bought” component of foreign banks’ assets, as shown in Figure 7.

  6. The t-statistic is −7.15.and the R2 is 0.34.

  7. There is some evidence that some of the funds captured in the interoffice accounts are used to purchase Japanese securities on the books of the headquarters bank. Thus, not all of the interoffice accounts will reflect funds channeled out of Japan for use overseas.

  8. The reason why we take changes rather than growth rates for the net interoffice accounts is that the series changes sign frequently, with some observations close to zero.

  9. We will see later some independent confirmation of the role of the interest rate differential.

  10. See also Burnside and others (2007) on the excess returns on the carry trade. See Gyntelberg and Remolona (2007) for the evidence of carry trades in other Asian currencies.

References

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Authors

Additional information

*Masazumi Hattori is director and senior economist, deputy head of economics section, Institute for Monetary and Economic Studies, Bank of Japan. Hyun Song Shin is professor of economics at Princeton University. The authors are grateful to Tam Bayoumi, Bob Flood, Kazuo Fukuda, Dick Herring, Isao Hishikawa, Wataru Takahashi and a referee for their suggestions, and to Tobias Adrian for encouragement and support.

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Hattori, M., Shin, H. Yen Carry Trade and the Subprime Crisis. IMF Econ Rev 56, 384–409 (2009). https://doi.org/10.1057/imfsp.2009.2

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  • DOI: https://doi.org/10.1057/imfsp.2009.2

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