Currency Crash Risk and Carry Trade: Evidence from Turkey
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SeriesResearch Master Defense
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SpeakerMerve Mavus Kutuk
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FieldMacroeconomics
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LocationRoom 1.60
Amsterdam -
Date and time
August 22, 2019
14:30 - 15:30
High interest rates in Turkish Lira (TL) denominated assets make TL an attractive currency for carry trade investment strategies. However, possibly large depreciations in TL can offset the high interest earning of investors. In this paper, we first investigate crash risk in TL using three different measures: skewness of exchange rate changes, risk reversals and crash probability implied by option-based the risk neutral probability distribution. Then, we analyze explanatory factors of apparently profitable TL-USD carry trade strategy. Our results show that investors demand a compensation for bearing high currency risk and available capital in Turkey determines the level of carry returns. Our results support that tighter funding constraints of investors before the investment period are associated with higher mispricing.