Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence

Matthew Ames, Gareth W. Peters, Guillaume Bagnarosa, Ioannis Kosmidis

Research output: Chapter in Book/Report/Conference proceedingChapter

Abstract

Currency carry trade is the investment strategy that involves selling low interest rate currencies in order to purchase higher interest rate currencies, thus profiting from the interest rate differentials. This is a well known financial puzzle to explain, since assuming foreign exchange risk is uninhibited and the markets have rational risk-neutral investors, then one would not expect profits from such strategies. That is, according to uncovered interest rate parity (UIP), changes in the related exchange rates should offset the potential to profit from such interest rate differentials. However, it has been shown empirically, that investors can earn profits on average by borrowing in a country with a lower interest rate, exchanging for foreign currency, and investing in a foreign country with a higher interest rate, whilst allowing for any losses from exchanging back to their domestic currency at maturity.

This paper explores the financial risk that trading strategies seeking to exploit a violation of the UIP condition are exposed to with respect to multivariate tail dependence present in both the funding and investment currency baskets. It will outline in what contexts these portfolio risk exposures will benefit accumulated portfolio returns and under what conditions such tail exposures will reduce portfolio returns.
Original languageEnglish
Title of host publicationInnovations in Quantitative Risk Management.
PublisherSpringer
Pages163-181
Number of pages19
ISBN (Electronic)9783319091143
ISBN (Print)9783319091136
DOIs
Publication statusPublished - 10 Jan 2015

Publication series

NameSpringer Proceedings in Mathematics & Statistics
PublisherSpringer
Volume99
ISSN (Print)2194-1009
ISSN (Electronic)2194-1017

Fingerprint

Downside risk
Risk exposure
Carry trade
Interest rates
Tail dependence
Currency
Profit
Uncovered interest rate parity
Interest rate differentials
Investors
Maturity
Currency basket
Exchange rates
Foreign exchange risk
Portfolio risk
Investment strategy
Financial risk
Trading strategies
Violations
Borrowing

Cite this

Ames, M., Peters, G. W., Bagnarosa, G., & Kosmidis, I. (2015). Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence. In Innovations in Quantitative Risk Management. (pp. 163-181). (Springer Proceedings in Mathematics & Statistics; Vol. 99). Springer. https://doi.org/10.1007/978-3-319-09114-3_10
Ames, Matthew ; Peters, Gareth W. ; Bagnarosa, Guillaume ; Kosmidis, Ioannis. / Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence. Innovations in Quantitative Risk Management.. Springer, 2015. pp. 163-181 (Springer Proceedings in Mathematics & Statistics).
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Ames, M, Peters, GW, Bagnarosa, G & Kosmidis, I 2015, Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence. in Innovations in Quantitative Risk Management.. Springer Proceedings in Mathematics & Statistics, vol. 99, Springer, pp. 163-181. https://doi.org/10.1007/978-3-319-09114-3_10

Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence. / Ames, Matthew; Peters, Gareth W.; Bagnarosa, Guillaume; Kosmidis, Ioannis.

Innovations in Quantitative Risk Management.. Springer, 2015. p. 163-181 (Springer Proceedings in Mathematics & Statistics; Vol. 99).

Research output: Chapter in Book/Report/Conference proceedingChapter

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Ames M, Peters GW, Bagnarosa G, Kosmidis I. Upside and Downside Risk Exposures of Currency Carry Trades via Tail Dependence. In Innovations in Quantitative Risk Management.. Springer. 2015. p. 163-181. (Springer Proceedings in Mathematics & Statistics). https://doi.org/10.1007/978-3-319-09114-3_10