Solvency Risk Premia and the Carry Trades

51 Pages Posted: 2 Feb 2018

See all articles by Vitaly Orlov

Vitaly Orlov

University of St. Gallen - School of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2018

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 Risk; Carry Trades; Risk Premia

JEL Classification: F31, G15

Suggested Citation

Orlov, Vitaly, Solvency Risk Premia and the Carry Trades (February 1, 2018). University of St.Gallen, School of Finance Research Paper No. 2018/02. Available at SSRN: https://ssrn.com/abstract=3116031 or http://dx.doi.org/10.2139/ssrn.3116031

Vitaly Orlov (Contact Author)

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

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

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