International Conference on Economics, Finance & Business, London

THE UNWINDING RISK OF THE JAPANESE CARRY TRADE: SCENARIOS FOR EQUITY AND BOND MARKETS

RUDOLF RUDYŠAR

Abstract:

The Japanese yen-funded carry trade – borrowing at Japan’s ultra-low interest rates to invest in higher-yield assets abroad – has grown extensively in recent years, raising concerns about its potential unwinding. This paper examines the risk of a disorderly unwind of yen carry trades and the consequent impact on equity and bond markets, with a focus on U.S. equities. We synthesize insights from academic literature and central bank reports, and we deploy simulation models (VAR, Monte Carlo, and regression-based analyses) to explore scenario outcomes. Our analysis suggests that a sharp yen appreciation (triggered by either Japanese policy tightening or U.S. rate cuts) could force carry traders to liquidate positions, causing significant volatility in stock markets and a spike in risk aversion. Through scenario analysis, we find that the severity of market impact depends on the speed and scale of unwinding – ranging from a mild normalization with limited market effects to a severe, rapid unwind that could resemble past crisis episodes. The results highlight the importance of monitoring carry trade-funded flows and ensuring market resilience to sudden reversals.

Keywords: Yen carry trade; Carry trade unwind; Equity markets; Bond markets; Interest rate differentials; Vector autoregression; Monte Carlo simulation; Safe-haven currency; Risk aversion; Capital flows