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Understanding the price of volatility risk in carry trades

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  • Ahmed, Shamim
  • Valente, Giorgio

Abstract

This paper investigates the cross-sectional pricing ability of the short- and long-run components of global foreign exchange (FX) volatility for carry trade returns. We find a negative and statistically significant factor risk price for the long-run component, but no significant pricing effect due to the short-run volatility component. We also document that the dynamics of the long-run component of global FX volatility are related to US macroeconomic fundamentals. Our results are robust to various parametrizations of the volatility models used to obtain the volatility components and they are invariant to alternative asset pricing testing methodologies and sample periods.

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  • Ahmed, Shamim & Valente, Giorgio, 2015. "Understanding the price of volatility risk in carry trades," Journal of Banking & Finance, Elsevier, vol. 57(C), pages 118-129.
    • Handle: RePEc:eee:jbfina:v:57:y:2015:i:c:p:118-129
    DOI: 10.1016/j.jbankfin.2015.04.002
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    Cited by:

    1. Byrne, Joseph P. & Ibrahim, Boulis Maher & Sakemoto, Ryuta, 2019. "Carry trades and commodity risk factors," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 121-129.
    2. Ulm, M. & Hambuckers, J., 2022. "Do interest rate differentials drive the volatility of exchange rates? Evidence from an extended stochastic volatility model," Journal of Empirical Finance, Elsevier, vol. 65(C), pages 125-148.
    3. Cepni, Oguzhan & Emirmahmutoglu, Furkan & Guney, Ibrahim Ethem & Yilmaz, Muhammed Hasan, 2023. "Do the carry trades respond to geopolitical risks? Evidence from BRICS countries," Economic Systems, Elsevier, vol. 47(2).
    4. Byrne, Joseph P. & Ibrahim, Boulis Maher & Sakemoto, Ryuta, 2018. "Common information in carry trade risk factors," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 52(C), pages 37-47.
    5. Yasuhiro Iwanaga & Ryuta Sakemoto, 2023. "Commodity momentum decomposition," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(2), pages 198-216, February.
    6. Cho, Dooyeon, 2021. "On the predictability of the distribution of excess returns in currency markets," International Journal of Forecasting, Elsevier, vol. 37(2), pages 511-530.
    7. Entrop, Oliver & Fuchs, Fabian U., 2020. "Implicit currency carry trades of companies," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe B-41-20, University of Passau, Faculty of Business and Economics.
    8. Eriksen, Jonas N., 2019. "Cross-sectional return dispersion and currency momentum," Journal of Empirical Finance, Elsevier, vol. 53(C), pages 91-108.

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    More about this item

    Keywords

    Carry trade; Forward premium puzzle; Volatility risk;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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