Understanding the price of volatility risk in carry trades

Ahmed, Shamim; Valente, Giorgio

Abstract

This paper investigates the cross-sectional pricing ability of the short- and long-run components of global foreign exchange (FX) volatility for carry trade returns. We find a negative and statistically significant factor risk price for the long-run component, but no significant pricing effect due to the short-run volatility component. We also document that the dynamics of the long-run component of global FX volatility are related to US macroeconomic fundamentals. Our results are robust to various parametrizations of the volatility models used to obtain the volatility components and they are invariant to alternative asset pricing testing methodologies and sample periods.

Citation

Ahmed, S., & Valente, G. (2015). Understanding the price of volatility risk in carry trades. Journal of Banking and Finance, 57, https://doi.org/10.1016/j.jbankfin.2015.04.002

• Journal Article Type: Article
• Acceptance Date: Apr 3, 2015
• Online Publication Date: Apr 9, 2015
• Publication Date: Aug 1, 2015
• Deposit Date: Sep 19, 2016
• Publicly Available Date: Sep 19, 2016
• Journal: Journal of Banking and Finance
• Print ISSN: 0378-4266
• Electronic ISSN: 1872-6372
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 57
• DOI: https://doi.org/10.1016/j.jbankfin.2015.04.002
• Keywords: Carry trade; Forward premium puzzle; Volatility risk
• Public URL: https://nottingham-repository.worktribe.com/output/982649
• Publisher URL: http://www.sciencedirect.com/science/article/pii/S0378426615000783
• Contract Date: Sep 19, 2016