Solvency risk premia and the carry trades

Vitaly Orlov

Journal of International Financial Markets, Institutions and Money, 2019, vol. 60, issue C, 50-67

Abstract: This paper shows that currency carry trades can be rationalized by the risk premia originating from the sovereign solvency risk. We find that solvency risk is a key determinant of risk premia in the cross section of carry trade returns, as its covariance with currency returns captures a substantial part of the cross-sectional variation of carry trade returns. Importantly, low interest rate currencies serve as insurance against solvency risk, while high interest rate currencies expose investors to more risk. The results are not attenuated by existing risks and pass a broad range of various robustness checks.

Keywords: Solvency risk; Carry trades; Risk premia (search for similar items in EconPapers)
JEL-codes: F31 G15 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:60:y:2019:i:c:p:50-67

DOI: 10.1016/j.intfin.2018.12.001

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