Intermediary asset pricing in currency carry trade returns

Libo Yin and Jing Nie

Journal of Futures Markets, 2021, vol. 41, issue 8, 1241-1267

Abstract: This paper examines how intermediary capital risk (ICR) is priced in currency carry trades. In both in‐sample and out‐of‐sample settings, ICR holds strong explanatory power for time‐series currency returns. ICR is also a key driver of currency returns with a positive risk price in the cross section, suggesting that financial intermediaries are marginal investors in currency markets. We find an asymmetric effect of ICR, with currencies being more sensitive to negative ICR. Moreover, heterogeneity of ICR is significant only for emerging economies, and the economic channel for the relationship stems from the influence of ICR on intermediary risk aversion.

Date: 2021
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https://doi.org/10.1002/fut.22198

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