The 'Greatest' Carry Trade Ever? Understanding Eurozone Bank Risks

51 Pages Posted: 29 Apr 2013 Last revised: 30 Sep 2015

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Sascha Steffen

Frankfurt School of Finance & Management; Centre for Economic Policy Research (CEPR)

Date Written: November 2, 2014

Abstract

We show that eurozone bank risks during 2007-2013 can be understood as carry trade behavior. Bank equity returns load positively on peripheral (Greece, Italy, Ireland, Portugal, Spain, or GIIPS) bond returns and negatively on German government bond returns, which generated carry until the deteriorating GIIPS bond returns adversely affected bank balance sheets. We find support for risk-shifting and regulatory arbitrage motives at banks in that carry trade behavior is stronger for large banks and banks with low capital ratios and high risk-weighted assets. We also find evidence for home bias and moral suasion in the subsample of GIIPS banks.

Keywords: Sovereign debt crisis, banking crisis, risk-shifting, regulatory arbitrage, home bias

JEL Classification: G01, G21, G28, G14, G15, F3

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Steffen, Sascha, The 'Greatest' Carry Trade Ever? Understanding Eurozone Bank Risks (November 2, 2014). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2257665 or http://dx.doi.org/10.2139/ssrn.2257665

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business ( email )

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HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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Centre for Economic Policy Research (CEPR) ( email )

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National Bureau of Economic Research (NBER) ( email )

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Sascha Steffen (Contact Author)

Frankfurt School of Finance & Management ( email )

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HOME PAGE: http://www.sascha-steffen.de

Centre for Economic Policy Research (CEPR) ( email )

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United Kingdom

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