Carry Trade and Currency Crash Risk

The paper questions whether the currency crash risk functions as a pricing factor in carry trade activies. We explore the currency crash risk measures can provide insight into understanding the dynamics of carry trade strategies and their associated returns. Our analysis using different currency crash risk measures documents that the carry returns are, indeed, driven by the crash risk of investment currency. By comparing the returns of unhedged and crash-hedged carry trade strategies, we assess the return that investors seek in response to currency crash risk. Our findings demonstrate that, on average, 62 percent of the carry returns can be attributed to the currency crash risk