Solvency Risk Premia and the Carry Trades

50 Pages Posted: 23 Feb 2016 Last revised: 6 Nov 2017

See all articles by Vitaly Orlov

Vitaly Orlov

University of St. Gallen - School of Finance; Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2017

Abstract

This 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 variation 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.

Keywords: Solvency; Carry Trades; Risk Premia

JEL Classification: F31, G15

Suggested Citation

Orlov, Vitaly, Solvency Risk Premia and the Carry Trades (October 1, 2017). Paris December 2016 Finance Meeting EUROFIDAI - AFFI, 29th Australasian Finance and Banking Conference 2016, Available at SSRN: https://ssrn.com/abstract=2735441 or http://dx.doi.org/10.2139/ssrn.2735441

Vitaly Orlov (Contact Author)

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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