We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates

/pdf/do-peso-problems-explain-the-returns-to-the-carry-trade-519fzuhdu7.pdf

Do Peso Problems Explain the Returns to the Carry Trade

We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs that are on average large and uncorrelated with traditional risk factors. We argue that these payoffs reflect a peso problem. The underlying peso event features high values of the stochastic discount factor rather than very large negative payoffs.

/pdf/do-peso-problems-explain-the-returns-to-the-carry-trade-58a3b5cgi5.pdf

Bid—ask spreads and volatility in the foreign exchange market: An empirical analysis

https://epge.fgv.br/we/MFEE/GerenciamentodeRisco/2011?action=AttachFile&do=get&target=Artigo42.pdf

Estimating ‘Value at Risk’ of crude oil price and its spillover effect using the GED-GARCH approach

This paper examines the stock price impact of terrorist attacks. Using an official list of terrorism-related incidents compiled by the Counterterrorism Office of the U.S. Department of State, we identify 75 attacks between 1995 and 2002 in which publicly traded firms are targets. An event-study analysis around the day of the attacks uncovers evidence of a statistically significant negative stock price reaction of -0.83%, which corresponds to an average loss per firm per attack of $401 million in firm market capitalization. A cross sectional analysis of the abnormal returns indicates that the impact of terrorist attacks differs according to the home country of the target firm and the country in which the incident occurred. Attacks in countries that are wealthier and more democratic are associated with larger negative share price reactions. Most interestingly, we find that human capital losses, such as kidnappings of company executives, are associated with larger negative stock price reactions than physical losses, such as bombings of facilities or buildings. We discuss the implications of these findings for existing research on terrorism and for current policy debates regarding terrorism re-insurance programs.

Terrorism and the Stock Market

This study examines the impact of forced bank mergers on the shareholders’ wealth of Malaysian banks. Forced bank mergers, which are the result of direct government intervention in the consolidation of the banking industry, are generally rare. Unlike the findings on voluntary mergers and acquisitions, our study shows that the forced merger scheme destroys economic value in aggregate and the acquiring banks tend to gain at the expense of the target banks. Further analysis shows that the contrasting forced merger finding is linked to cronyism.

The wealth effect of forced bank mergers and cronyism

Time-series evidence yields estimates of the increase in the spread on the South African rand on days when riots, demonstrations, armed attacks, and related deaths occur in South Africa. The cross-section evidence demonstrates how spreads vary across thirty-six industrial and developing countries as spot rate volatility and country risk vary. Both the changes in the spread over time for particular countries and the changes in the spread across the countries at a particular time appear to be significantly related to countries' risk differences and exchange-rate volatility. Copyright 1996 by Royal Economic Society.

Foreign exchange market bid—ask spreads and the market price of social unrest

The paper ascertains the relation between bid-ask spreads and the contract maturity of OTC currency options. Contrary to previous findings in the futures market, spreads of currency options are found to be negatively related to the contract's term-to-maturity. The negative relation persists even after controlling for the effects of price risks, competition, and trading activity. The pronounced differences in the term-to-maturity results are attributable to the market risk effect and differences in the market structure of options and futures markets.

https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=2159&context=lkcsb_research

Maturity Effect on Bid-Ask Spreads of OTC Currency Options

In this article, long-run and short-run relationships among real interest rates in G-7 countries are empirically analyzed. The evidence suggests the existence of long-run relationships among these real interest rates. However, the long-run relationship is not an equality relationship. Short-run relationships are estimated using dynamic simultaneous equation models. They reveal that the real interest rates of non-U.S. G-7 countries react and adjust to long-run disequilibrium conditions. A more detailed analysis based on wavelet transform indicates the existence of both short-run and long-run relationships; however, strict interest rate parity does not seem to hold true.

Kok-Hui Tan

Papers

The wealth effect of forced bank mergers and cronyism

Foreign exchange market bid—ask spreads and the market price of social unrest

Maturity Effect on Bid-Ask Spreads of OTC Currency Options

Real Interest Rate Parity: Long-Run and Short-Run Analysis Using Wavelets

Stress testing using VaR approach—a case for Asian currencies