Bank default risk and carry trade profit

Daehwan Kim and Chi-Young Song

Economics Letters, 2015, vol. 130, issue C, 117-119

Abstract: Currency carry trades–buying high-deposit-rate currencies and selling low-deposit-rate currencies–earn positive excess returns over time. The literature has heretofore explained this phenomenon based on currency differences. We examine the possibility that the bank default risk of destination countries contributes to positive carry trade profit. We measure the bank default risk of a country by averaging the distance to default–an option-pricing-based measure of default risk–of individual banks in that country. The average distance to default is strongly correlated both with deposit rate and with currency excess return. Also, “distance-to-default premium” explains a significant part of the time variation in carry trade profit.

Keywords: Carry trade profit; Bank default risk; Distance to default (search for similar items in EconPapers)
JEL-codes: F31 G21 G33 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:130:y:2015:i:c:p:117-119

DOI: 10.1016/j.econlet.2015.03.018

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