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The Determinants of Carry Trade Risk Premia

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Aidan Corcoran

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Abstract

This paper tests a novel explanation for excess returns to the carry trade, namely, that investors are rewarded for exposure to equity risk of the target country. This risk factor is motivated via a hedging argument, whereby investors reallocate portfolio holdings to government debt in response to an increase in equity risk. Data from 1952 to 2007 on a broad sample of countries are used to test this hypothesis in an asset pricing framework which controls for global equity returns, exchange rate volatility, and global consumption factors. Target currency equity returns are found to be a priced risk factor after controlling for these factors. Implications for the diversi cation of international portfolio risk are discussed.

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp287.

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Date of creation: 03 2009
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Handle: RePEc:iis:dispap:iiisdp287

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. Richard Clarida & Daniel Waldman, 2007. "Is Bad News About Inflation Good News for the Exchange Rate?," NBER Working Papers 13010, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany. [Downloadable!]
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  5. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Hanno Lustig & Adrien Verdelhan, 2008. "Note on The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," NBER Working Papers 13812, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, vol. 97(1), pages 89-117, March. [Downloadable!]
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  14. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December. [Downloadable!] (restricted)
  15. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York. [Downloadable!]
  16. A. Craig Burnside & Martin S. Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2008. "Do Peso Problems Explain the Returns to the Carry Trade?," NBER Working Papers 14054, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  1. Vistesen, Claus, 2009. "Carry Trade Fundamentals and the Financial Crisis 2007-2010," MPRA Paper 9952, University Library of Munich, Germany. [Downloadable!]
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