The Determinants of Carry Trade Risk Premia

Aidan Corcoran

The Institute for International Integration Studies Discussion Paper Series from IIIS

Abstract: This paper tests a novel explanation for excess returns to the carry trade, namely, that investors are rewarded for exposure to equity risk of the target country. This risk factor is motivated via a hedging argument, whereby investors reallocate portfolio holdings to government debt in response to an increase in equity risk. Data from 1952 to 2007 on a broad sample of countries are used to test this hypothesis in an asset pricing framework which controls for global equity returns, exchange rate volatility, and global consumption factors. Target currency equity returns are found to be a priced risk factor after controlling for these factors. Implications for the diversi cation of international portfolio risk are discussed.

New Economics Papers: this item is included in nep-cba
Date: 2009
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