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The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks

  • Viral V. Acharya
  • Sascha Steffen

We show that Eurozone bank risks during 2007-2012 can be understood as a "carry trade" behavior. Bank equity returns load positively on peripheral (Greece, Ireland, Portugal, Spain and Italy, or GIPSI) bond returns and negatively on German government bond returns, a position that generated "carry" until the deteriorating GIPSI bond returns inflicted losses on banks. The positive GIPSI loadings correlate with banks' holdings of GIPSI bonds; and, the negative German loading with banks' short-term debt exposures. Consistent with moral hazard in the form of risk-taking by large, under-capitalized banks to exploit government guarantees, arbitrage regulatory risk weights, and access central-bank funding, we find that this carry-trade behavior is stronger for large banks, and banks with low Tier 1 ratios and high risk-weighted assets, in both GIPSI and non-GIPSI countries' banks, but not so for similar banks in other Western economies or for non-bank firms.

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File URL: http://www.nber.org/papers/w19039.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19039.

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Date of creation: May 2013
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Publication status: published as Journal of Financial Economics Volume 115, Issue 2, February 2015, Pages 215–236 Cover image The “greatest” carry trade ever? Understanding eurozone bank risks ☆ Viral V. Acharyaa, , 1, , Sascha Steffenb, 2,
Handle: RePEc:nbr:nberwo:19039
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  1. Nicola Gennaioli & Alberto Martin & Stefano Rossi, 2012. "Sovereign Default, Domestic Banks, and Financial Institutions," Working Papers 462, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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