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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.

Suggested Citation

  • 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. repec:eee:intfin:v:52:y:2018:i:c:p:37-47 is not listed on IDEAS
    2. repec:eee:jimfin:v:96:y:2019:i:c:p:121-129 is not listed on IDEAS
    3. 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.
    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.

    More about this item

    Keywords

    Carry trade; Forward premium puzzle; Volatility risk;

    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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