In The Rise of Carry (Chapter 4) we document an increasing correlation between currency carry returns and equity volatility. This paper presents a more formal test of this and finds that a generic short volatility strategy as proxied by a VIX futures roll down strategy subsumes currency carry return. They also find that a currency carry strategy hedged with options remains profitable, particularly for carry strategies funded from ultra-low interest rate currencies like the Swiss franc and Japanese yen. Professional traders that we know were somewhat sceptical of these results and it should be noted that option prices used in this analysis are not actual market prices but those implied by implied volatility quotes.
Caballero, Ricardo J. and Doyle, Joseph B., Carry Trade and Systemic Risk: Why are FX Options so Cheap? (December 2012). NBER Working Paper No. w18644
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