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Solvency Risk Premia and the Carry Trades

Vitaly Orlov ()

No 1802, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: The paper shows that currency carry trades can be rationalized by the time-varying 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 returns captures a substantial part of the cross-sectional vraiation 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)
New Economics Papers: this item is included in nep-rmg
Date: 2018-02
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Persistent link: https://EconPapers.repec.org/RePEc:usg:sfwpfi:2018:02

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