NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The “Greatest” Carry Trade Ever? Understanding Eurozone Bank Risks

Viral V. Acharya, Sascha Steffen

NBER Working Paper No. 19039
Issued in May 2013
NBER Program(s):   AP   CF   IFM   ME

We show that Eurozone bank risks during 2007-2012 can be understood as a “carry trade” behavior. Bank equity returns load positively on peripheral (Greece, Ireland, Portugal, Spain and Italy, or GIPSI) bond returns and negatively on German government bond returns, a position that generated “carry” until the deteriorating GIPSI bond returns inflicted losses on banks. The positive GIPSI loadings correlate with banks’ holdings of GIPSI bonds; and, the negative German loading with banks’ short-term debt exposures. Consistent with moral hazard in the form of risk-taking by large, under-capitalized banks to exploit government guarantees, arbitrage regulatory risk weights, and access central-bank funding, we find that this carry-trade behavior is stronger for large banks, and banks with low Tier 1 ratios and high risk-weighted assets, in both GIPSI and non-GIPSI countries’ banks, but not so for similar banks in other Western economies or for non-bank firms.

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Document Object Identifier (DOI): 10.3386/w19039

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