A value-at-risk analysis of carry trades using skew-GARCH models

Wang Yu-Jen (), Chung Huimin and Guo Jia-Hau
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Wang Yu-Jen: Graduate Institute of Finance, National Chiao Tung University, 1001 Ta-Hsueh Road, Hsinchu 30050, Taiwan
Chung Huimin: National Chiao Tung University, Hsinchu, Taiwan
Guo Jia-Hau: National Chiao Tung University, Hsinchu, Taiwan

Studies in Nonlinear Dynamics & Econometrics, 2013, vol. 17, issue 4, 439-459

Abstract: We carry out a value-at-risk (VaR) analysis of an extremely popular strategy in the currency markets, namely, “carry trades,” whereby a position purchased in high interest rate currencies is funded by selling low interest rate currencies. Since the natural outcome of the truncated normal distribution of interest-rate spreads combined with the normal distribution of exchange rate returns is a skew-normal distribution, we consider a skew-normal innovation with zero mean for our analysis of carry trade returns using generalized autoregressive conditional heteroskedasticity (GARCH) models. The stress testing results reveal that skew-normal or densities are suitable for the measurement of VaR for carry trade returns involving, for example, taking up a long position in Australian Dollars or Argentine Peso which are funded by selling Japanese Yen.

Keywords: currency markets; carry trade; skew-normal GARCH; EM-type Algorithm (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1515/snde-2012-0028

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