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

Author

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  • Wang Yu-Jen

    (Graduate Institute of Finance, National Chiao Tung University, 1001 Ta-Hsueh Road, Hsinchu 30050, Taiwan)

  • Chung Huimin

    (National Chiao Tung University, Hsinchu, Taiwan)

  • Guo Jia-Hau

    (National Chiao Tung University, Hsinchu, Taiwan)

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 skew-normal 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.

Suggested Citation

  • Wang Yu-Jen & Chung Huimin & Guo Jia-Hau, 2013. "A value-at-risk analysis of carry trades using skew-GARCH models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(4), pages 439-459, September.
    • Handle: RePEc:bpj:sndecm:v:17:y:2013:i:4:p:439-459:n:2
    DOI: 10.1515/snde-2012-0028
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    References listed on IDEAS

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