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Solvency Risk Premia and the Carry Trades

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  • Vitaly Orlov

Abstract

The paper shows that currency carry trades can be rationalized by the time-varying 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 returns captures a substantial part of the cross-sectional vraiation 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

  • Vitaly Orlov, 2018. "Solvency Risk Premia and the Carry Trades," Working Papers on Finance 1802, University of St. Gallen, School of Finance.
    • Handle: RePEc:usg:sfwpfi:2018:02
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    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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