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Solvency risk premia and the carry trades

Author

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  • Orlov, Vitaly

Abstract

This paper shows that currency carry trades can be rationalized by the risk premia originating from the sovereign solvency risk. We find that solvency risk is a key determinant of risk premia in the cross section of carry trade returns, as its covariance with currency returns captures a substantial part of the cross-sectional variation of carry trade returns. Importantly, low interest rate currencies serve as insurance against solvency risk, while high interest rate currencies expose investors to more risk. The results are not attenuated by existing risks and pass a broad range of various robustness checks.

Suggested Citation

  • Orlov, Vitaly, 2019. "Solvency risk premia and the carry trades," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 60(C), pages 50-67.
    • Handle: RePEc:eee:intfin:v:60:y:2019:i:c:p:50-67
    DOI: 10.1016/j.intfin.2018.12.001
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    Cited by:

    1. Libo Yin & Jing Nie, 2021. "Intermediary asset pricing in currency carry trade returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(8), pages 1241-1267, August.
    2. Byrne, Joseph P. & Sakemoto, Ryuta, 2021. "The conditional volatility premium on currency portfolios," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 74(C).

    More about this item

    Keywords

    Solvency risk; Carry trades; Risk premia;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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