The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks

Viral Acharya and Sascha Steffen

No 19039, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that Eurozone bank risks during 2007-2012 can be understood as a "carry trade" behavior. Bank equity returns load positively on peripheral (Greece, Ireland, Portugal, Spain and Italy, or GIPSI) bond returns and negatively on German government bond returns, a position that generated "carry" until the deteriorating GIPSI bond returns inflicted losses on banks. The positive GIPSI loadings correlate with banks' holdings of GIPSI bonds; and, the negative German loading with banks' short-term debt exposures. Consistent with moral hazard in the form of risk-taking by large, under-capitalized banks to exploit government guarantees, arbitrage regulatory risk weights, and access central-bank funding, we find that this carry-trade behavior is stronger for large banks, and banks with low Tier 1 ratios and high risk-weighted assets, in both GIPSI and non-GIPSI countries' banks, but not so for similar banks in other Western economies or for non-bank firms.

JEL-codes: F3 G01 G14 G15 G21 G28 (search for similar items in EconPapers)
Date: 2013-05
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Published as Journal of Financial Economics Volume 115, Issue 2, February 2015, Pages 215–236 Cover image The “greatest” carry trade ever? Understanding eurozone bank risks ☆ Viral V. Acharyaa, , 1, , Sascha Steffenb, 2,

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Journal Article: The “greatest” carry trade ever? Understanding eurozone bank risks (2015)
Working Paper: The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks (2013)
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