Carry Factor

Carry is the return an asset earns if its price does not change. A currency with a high interest rate, a bond with a high yield and roll down, a commodity in backwardation and a stock index with a high dividend yield all have positive carry. The carry factor systematically buys high carry assets and sells low carry assets across a market. Research has found carry premiums in almost every major asset class, along with a shared vulnerability to sharp losses in crises. The trading strategy view is covered in Carry Trading; this lesson treats carry as a systematic factor.

Measuring carry by asset class#

Koijen, Moskowitz, Pedersen and Vrugt (2018) defined carry consistently across assets as the expected return from futures converging to spot if prices stay the same.

carry ≈ (spot price - futures price) / futures price, scaled to an annual rate

The evidence#

• Currency carry has earned positive average returns for decades, as documented by many studies, despite theory suggesting it should not (the forward premium puzzle). See Covered and Uncovered Interest Parity.
• Koijen et al. (2018) found carry strategies earned positive returns in equities, bonds, commodities, currencies, credit and options, and that a diversified global carry portfolio had a Sharpe ratio around 1 historically.

Constructing a carry factor#

Why might carry work?#

Crash risk#

Carry strategies show negative skewness: steady gains with occasional sharp losses during market stress, such as October 2008, when high yielding currencies collapsed against the yen, or August 2024. Losses across asset classes can happen at the same time, reducing the benefit of diversification. See Skewness and Kurtosis and Fat Tails.

Managing carry risk#

1. Diversify across asset classes, which reduces but does not remove crash correlation.
2. Combine with momentum or trend: trend filters can reduce exposure when carry trades unwind. See Trend Following.
3. Scale by volatility and reduce exposure when volatility spikes.
4. Combine with value: expensive high yielders may be riskier.

Carry and other factors#

Carry often combines well with momentum and value. Momentum helps exit carry trades when they start to unwind, and value helps avoid high yielders whose prices are already stretched. A blend of the three has historically been smoother than carry alone. See Combining Signals.

Frequently asked questions#

What is the carry factor?#

A systematic strategy that buys higher yielding or higher carry assets and sells lower yielding ones, earning the yield difference if prices stay stable.

Does carry work outside currencies?#

Research has found carry premiums in bonds, commodities, equity indices, credit and options as well as currencies.

What is the main risk of carry?#

Sudden crashes during market stress, when carry positions across many assets tend to lose money together.

Next, learn about the premium for illiquidity in Liquidity Factor.