27 Carry and Trend in Lots of Places

Vineer Bhansali, Josh Davis, Matt Dorsten, and Graham Rennison

There is a long history of using yields as the baseline for prospective asset returns for a wide variety of asset classes. For instance, Cochrane points out that yields predicting future returns is a “pervasive phenomenon” across markets (Cochrane [2011]) and Leibowitz [2014] applies this systematically to various types of bond portfolios. “Carry” is used by practitioners in an analogous way to yield, especially for derivatives markets like futures, and indeed is more general than yield in that it incorporates the cost of funding the investment. For fixed income investments, this distinction between yield and carry can be important, for instance, when yield curves are inverted.

If we decompose the total return of any investment as the sum of returns from change in the underlying pricing factors and from the passage of time, then carry can be best thought of as the return attributable to the second component, i.e., the expected return from the passage of time. Carry is defined by Koijen [2007] as the “expected return on an asset assuming that market conditions, including its price, stay the same.” Thus, carry may be thought of as a naïve, yet robust, model-free measure of the risk premium in a given asset class. In this regard, it is plausible that being on the side of positive carry should earn a higher return, on average, but accepting potentially greater risk as well since ...

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