Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/331486 
Year of Publication: 
2025
Series/Report no.: 
Tinbergen Institute Discussion Paper No. TI 2025-058/IV
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
This paper examines the role of currency crash risk in explaining the persistent profitability of carry trades. Focusing on the US Dollar-Turkish Lira market, we construct three forwardlooking measures of crash risk: risk reversals, crash probabilities from option-implied distributions, and jump risk from a jump-diffusion model. Using survey-based exchange rate expectations, we separate ex ante carry premia from ex post surprises. Our results show that higher crash risk significantly increases expected returns, indicating that investors demand compensation for bearing such risk rather than arbitraging away mispricing. Shapley decomposition attributes over 20% of the explained variance in expected carry returns to crash risk, while balance sheet constraints and global risk aversion further reinforce premia. A comparison of hedged and unhedged strategies reveals that 46-77% of carry returns reflect compensation for crash exposure.
Subjects: 
Exchange rates
currency crash risk
mispricing
dollar exchange rate
bank currency mismatches
JEL: 
F13
G01
G10
G12
G15
Document Type: 
Working Paper

Files in This Item:
File
Size





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.