The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis (BUSINESS BOOKS)

Product Information

He is a co-author of The Rise of Carry (2020). He is also the author of the highly regarded Economics for Professional Investors (2nd edition 1998) along with many articles in newspapers and journals. His commentaries and analyses have been widely quoted. The book defines carry trade as risk bets where investors win if nothing happens. Examples of such bets are currency carry trades, as well as the sale of naked put options. After defining the core concept, the book details the history of financial markets since the 1990s, when the volatility suppression regime emerged. Also, in the end, you will find a cursory prediction of what such a regime can lead to. that serial reflations of ever increasing sizes lead to systemic overleverage and debt overhang which is ultimately deflationary (eg Japan and now much of developed world)

Simply put, carry trading is now the primary determinant of the global business cycle - a pattern of long, steady but unspectacular expansions punctuated by catastrophic crises. Jamie Lee works for investment guru and philanthropist Jeremy Grantham, focusing on environmental research and volatility trading. He previously worked as economist and analyst for asset management companies in Boston and London. Jamie holds a B.A. in Mathematics and English from Dartmouth College. The book only briefly mentions the accumulation of moral hazard. However, in my opinion, this is where the main problem lies. In the institutions that run the society, the proportion of idiots has been steadily increasing for many decades. It is now close to 100%. Simply put, carry trading is now the primary determinant of the global business cycle—a pattern of long, steady but unspectacular expansions punctuated by catastrophic crises.

Create a new list

Fighting the crisis means increasing the chances of higher inflation. Since crisis risk in more salient and more immediate, it will always get priority. The logical conclusion is that inflation will not return to 2% for a sustained period. Protect yourself from the next financial meltdown with this game-changing primer on financial markets, the economy--and the meteoric rise of carry. Holding a short position in volatility, by contrast, produces steady profits at the expense of occasional large losses. In the event of higher volatility, those who provide insurance against such an increase have a high risk of going bankrupt—a risk that is amplified if, as seems most often to be the case, they are leveraged. Thus a rise in volatility has the potential to set off a vicious cycle: when volatility rises, the cost of insuring against both gamma and vega risks will likewise rise; as a result of this increased cost, the market will become less liquid, and the decline in liquidity is itself likely to enhance volatility.

Volatility insurance differs in one important respect from other common forms of insurance (such as life, home, and vehicle insurance), which allow the specific risk of events to be pooled. In these forms of insurance, the aggregate risks taken by insurers are significantly less than the sum of the individual risks. Homeowners who buy fire insurance, for instance, pay regular premiums and are pro­tected thereby against loss. The number of houses destroyed by fire annually does not vary much from year to year, and so the insurance industry’s total income is sufficient each year to pay for the individual costs without being at risk of significant overall loss, although profits will fluctuate as fire damage varies from year to year. But this common sort of risk pooling is not characteristic of the carry trade, in which the aggregate risk is systemic rather than specific. For me, the conclusion of the book is - the rich get richer because they never actually have to face consequences of their investment strategies. This is based on the fact that there is extreme volatility suppression aided by central banks. Of course, “solvent but illiquid” is exactly the situation SVB was said to be in. Expect to hear this messaging a lot more in the coming years. The line between market support and QE will become increasingly blurry and, as it does, the risk of much higher inflation will increase. Volatility suppression happens in both the currency markets as well as other equities (in today's age they are very highly correlated) and allows for the use of extreme 'carry' as an investing strategy. The authors do not make this distinction sufficiently clear, defining carry as a trade with ‘short exposure to volatility’. This is correct for short volatility trading, but not for FX carry where only volatility in the wrong direction is problematic. But perhaps I am being too pedantic. Higher yielding currencies are usually emerging markets. These get hurt when risk levels are elevated, whilst lower yielding currencies are normally ‘safe havens’ like the US and Japan.Both the extremely high level of the equity market, which cur­rently matches the previous peaks of 1929 and 2000, 18 and the low level of volatility over the past decade, indicate that we face a high risk of a major bear market. The Rise of Carry provides a timely des­cription of how this situation has arisen and an urgent warning of dangers ahead. This article originally appeared in American Affairs Volume V, Number 2 (Summer 2021): 46–59. We will only delve on as much history as needed to construct the foundation. At the precipice of the 2008 GFC, liquidity seized, and interbank trust evaporated. The fed’s immediate actions of: These characteristics are reflected in the options market on which the VIX is based. As both put and call options provide the same cover against market volatility, the prices of the two exhibit a phenomenon known as “put-call parity,” diverging little from each other.

The main reason for the surge upwards in the indicator, to unprecedented levels, is the collapse of money supply, with my estimate being that for Q1 M2 will be -2.6% year-on-year, unprecedented in modern history. Because there exists an risk-of-ruin, and the manifestation of which on a large scale in unacceptable to the central bank: If you think easing and tightening at the same time sounds like a contradiction, sounds like a loss of control, I’m with you. Kevin Coldiron is a Lecturer in the Financial Engineering program at U.C. Berkeley’s Haas Business School. Financial instability has thus risen as the carry trade has grown. The Rise of Carry does not estimate the size of the market, for which reliable data do not seem to be available, but the authors argue convincingly that it is very large and has expanded greatly in recent years. They also point to the risk that volatility in different financial assets may be contagious: “There is also evidence of a growing correlation between currency and equity market carry, suggesting that a single global volatility risk factor may be a driver of all forms of carry in the future. If this is true, future carry crashes may impact on all asset classes at the same time.” 7carry traders are often forced to close positions when prices move against them. This necessarily means selling assets that are falling in price (or buying assets that are rising in price). Thus, the dynamics of managing carry trade risks create fire-sale effects in which initial movements in prices are often substantially amplified. The expansion of carry trades always increases liquidity; the reduction or closing of carry trades leads to liquidity contraction (p. 3, LL&C). These data show that daily price changes of U.S. equities followed a random walk when measured over the whole span from 1927 to 2020. The actual variance over periods of one to thirty-two days is almost exactly the same as that implied by the daily variance (vari­ance, the square of the standard deviation, is a measure of volatility). Price changes do not, however, show a consistent pattern when measured over shorter time periods: since 1945 there has been a sharp positive serial correlation for one-day changes measured over periods of one to eleven years, but steady negative serial correlation there­after. Yet the authors are correct in claiming that daily price changes have shown a negative serial correlation since 1987. However these issues are all fairly well documented and have been mainstream consciousness for quite a long time. So the book hardly broke any new ground here. But at least they are coherently articulated with no obvious logical fallacies. In this book we define all carry trades to share certain critical features : leverage, liquidity provision, short exposure to volatility, and a “sawtooth” return pattern of small, steady profits punctuated by occasional large losses (p. 3, LL&C).