Currency Regimes, Volatility Risks, and Carry Trades: The Option Value of Government Currency Intervention in Emerging Markets

57 Pages Posted: 18 Oct 2018 Last revised: 31 Oct 2019

See all articles by Wenliang Guo

Wenliang Guo

Tsinghua University, PBC School of Finance

Date Written: October 30, 2019

Abstract

This study investigates the relationship between cross-sectional carry trade returns and global foreign exchange volatility risk. During periods of high volatility innovations, the average carry trade returns on emerging markets are higher than that of all countries or developed economies. Furthermore, the average returns on managed-float and fixed-rate carry trades are significantly higher than that of free-float carry trade. Government currency intervention in emerging markets can explain these differences. There is an option value in government currency intervention, which can be calculated using an American currency option model with stochastic strikes. This result has policy implications.

Keywords: Carry Trade, Emerging Market, Currency Regime, Currency Intervention, Currency Option

JEL Classification: F31, G12, G18

Suggested Citation

Guo, Wenliang, Currency Regimes, Volatility Risks, and Carry Trades: The Option Value of Government Currency Intervention in Emerging Markets (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=3226712 or http://dx.doi.org/10.2139/ssrn.3226712

Wenliang Guo (Contact Author)

Tsinghua University, PBC School of Finance ( email )

No. 43, Chengdu Road
Beijing 100083
China

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