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

51 Pages Posted: 29 Apr 2013 Last revised: 30 Sep 2015

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Sascha Steffen

Frankfurt School of Finance & Management

Date Written: November 2, 2014

Abstract

We show that eurozone bank risks during 2007-2013 can be understood as carry trade behavior. Bank equity returns load positively on peripheral (Greece, Italy, Ireland, Portugal, Spain, or GIIPS) bond returns and negatively on German government bond returns, which generated carry until the deteriorating GIIPS bond returns adversely affected bank balance sheets. We find support for risk-shifting and regulatory arbitrage motives at banks in that carry trade behavior is stronger for large banks and banks with low capital ratios and high risk-weighted assets. We also find evidence for home bias and moral suasion in the subsample of GIIPS banks.

Keywords: Sovereign debt crisis, banking crisis, risk-shifting, regulatory arbitrage, home bias

JEL Classification: G01, G21, G28, G14, G15, F3

Suggested Citation

Acharya, Viral V. and Steffen, Sascha, The 'Greatest' Carry Trade Ever? Understanding Eurozone Bank Risks (November 2, 2014). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2257665 or http://dx.doi.org/10.2139/ssrn.2257665

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Sascha Steffen (Contact Author)

Frankfurt School of Finance & Management ( email )

Sonnemannstr. 9 -11
Frankfurt, 60314
Germany

HOME PAGE: http://www.sascha-steffen.de

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