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Time-Varying Risk Aversion and the Profitability of Carry Trades: Evidence from the Cross-Quantilogram

Riza Demirer, Rangan Gupta, Hossein Hassani () and Xu Huang ()
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Hossein Hassani: The Statistical Research Centre, Bournemouth University, Bournemouth, UK
Xu Huang: Faculty of Business and Law, De Montfort University, Leicester LE1 9BH, UK

No 201979, Working Papers from University of Pretoria, Department of Economics

Abstract: This paper examines the predictive power of time-varying risk aversion over payoffs to the carry trade strategy via the cross-quantilogram methodology of Han et al., (2016). Our analysis yields significant evidence of directional predictability from risk aversion to daily carry trade returns tracked by Deutsche Bank G10 Currency Future Harvest Total Return Index. The predictive power of risk aversion is found to be stronger during periods of moderate to high risk aversion and largely concentrated on extreme fluctuations in carry trade returns. While large crashes in carry trade returns are associated with significant rises in investors’ risk aversion, we also find that booms in carry trade returns can be predicted at high quantiles of risk aversion. The results highlight the predictive role of extreme investor sentiment in currency markets and regime specific patterns in carry trade returns that can be captured via quantile-based predictive models.

Keywords: Quantile; Correlogram; Dependence; Predictability (search for similar items in EconPapers)
JEL-codes: C22 F31 (search for similar items in EconPapers)
Pages: 16 pages
Date: 2019-11
New Economics Papers: this item is included in nep-fmk and nep-ore
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