A value-at-risk analysis of carry trades using skew-GARCH Models

Yu Jen Wang*, Huimin Chung, Jia-Hau Guo

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

We carry out a value-at-risk (VaR) analysis of an extremely popular strategy in the currency markets, namely, "carry trades," whereby a position purchased in high interest rate currencies is funded by selling low interest rate currencies. Since the natural outcome of the truncated normal distribution of interest-rate spreads combined with the normal distribution of exchange rate returns is a skew-normal distribution, we consider a skew-normal innovation with zero mean for our analysis of carry trade returns using generalized autoregressive conditional heteroskedasticity (GARCH) models. The stress testing results reveal that skewnormal or densities are suitable for the measurement of VaR for carry trade returns involving, for example, taking up a long position in Australian Dollars or Argentine Peso which are funded by selling Japanese Yen.

Original languageEnglish
Pages (from-to)439-459
Number of pages21
JournalStudies in Nonlinear Dynamics and Econometrics
Volume17
Issue number4
DOIs
StatePublished - 1 Sep 2013

Keywords

  • Carry trade
  • Currency markets
  • Em-type algorithm
  • Skew-normal garch

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