By Sam van de Schootbrugge 23-09-2020

Excess Returns In FX Volatility Markets

(4 min read)
Resize text:

The academic paper we review this week shows that a carry trade in volatility, a long-short strategy that buys implied volatility at a discount and sells implied volatility at a premium, generates a significant Sharpe ratio. The associated volatility returns are virtually uncorrelated with the traditional carry trade and other popular currency strategies.

The Study in a Nutshell

There is a growing body of literature documenting the existence of pronounced volatility risk premia, particularly in the short run. A new paper, published in the Journal of Financial Economics, investigates the properties of these premia in FX markets by examining the cross-sectional differences in the returns of forward volatility agreements (FVAs).

Their analysis yields two key results:

A zero-cost strategy that buys FVAs with downward sloping implied volatility curves and sells FVAs with upward sloping curves (a vol:carry strategy) generates significant excess returns.
The volatility carry premium remains both statistically and economically large for the implied volatility curve out to two years.

The proposed vol:carry (VCA) strategy outperforms the traditional FX carry trade strategy whereby an investor is long currencies with high yields and short currencies with low yields.


£39/month thereafter

For access to our Slack Chat Room, where we discuss all things markets with our researchers and subscribers



ECB Preview: Biding Time Until June (2 min read)

By Caroline Grady | Apr 20, 2021
Stepped up PEPP purchases since the 11 March ECB meeting leave little need for any policy changes at this week’s governing council meeting...

Russia Sanctions: The Shock That Never Came (5 min read)

By Tatiana Orlova | Apr 16, 2021
The most important measure bars US entities from newly issued local sovereign debt, effective from 14 June. The ban includes debt issued by the CBR...

Weekly Vaccination Update: J&J Pause and EU Supply Schedule (1 min read)

By Sam van de Schootbrugge | Apr 14, 2021
In this prime tracker, we review the latest vaccine developments globally. This week, we’ve added some brief commentary...


ECB Preview: Biding Time Until June (2 min read)

By Caroline Grady | Apr 20, 2021
Summary Thursday’s ECB meeting is unlikely to…

Five Things You Did Not Know About China (2 min read)

By Bilal Hafeez | Apr 13, 2021
China is a global economic superpower, yet…

Want To Join Our Community Of Leading Investors And Researchers In Our Slack Chat Room?