Currency excess returns and global downside market risk

The tail risk premia of the carry trades

“…Also, using Monte Carlo simulations, we are able to show that this interaction of the moments might price the return to the carry trade even in samples where, taken in isolation, the moment would not -thus offering a more general answer to the carry trade puzzle. Notably, our result echoes the work of Harvey and Siddique (2000) who propose a model in which they consider both volatility and skewness as drivers of investor behavior in the equity market 5 .…”

“…They suggest that when the return to the equity market portfolio (CAPM) lies at the left of certain pre-defined quantiles, it might price the return to the carry trade. Especially Dobrynskaya (2014) and Atanasov and Nitschka (2014) focus on the subsample of observations conditioned by the negativity of the return to the equity portfolio while Lettau, Maggiori and Weber (2014) consider only the episodes when the market return is below one standard-deviation. Our work is actually closer to Lustig et al (2011), Menkhoff et al (2012), Rafferty (2011) and Burnside (2012) as we propose a factor mimicking the time varying tail risk in the currency market which we think is a good candidate to price the full distribution of the returns to the carry trade.…”

“…This paper is organized as follows: section one is for this introduction; in section two, we describe the way we build the portfolios of carry trade positions. We also present the data and 5 Interestingly, Harvey and Siddique (2000) mention that volatility and skewness may both drive investor behavior because, among other reasons, the regulatory framework imposes VaR-based funding constraints. 6 An alternative solution to the puzzle is the peso story: risk averse agents assign small but non-zero probabilities to rare events with a larger negative payoff than can be observed in samples.…”

Conditional interest rate risk and the cross‐section of excess stock returns

“…Bawa and Lindenberg (1977) and Ang, Chen, and Xing (2006), for example, introduce (conditional) upside and downside market betas which measure sensitivities of stock return to the market over periods of high and low market return. More recently, Lettau, Maggiori, and Weber (2014), Dobrynskaya (2014), and Atanasov and Nitschka (2014) employ akin risk measures to study conditional market risk in the cross‐section of foreign exchange rate returns and returns on assets in other classes such as equities, commodities, sovereign bonds, and index options. Analogously, Delisle, Doran, and Peterson (2011) allow for different return sensitivities to upside and downside implied systematic volatility.…”

Common Information in Carry Trade Risk Factors

“…Atanasov andNitschca (2014), Dobrynskaya (2014), and Lettau et al (2014) investigate downside stock market risk for the FX market.…”