Systemic risk in carry-trade portfolios

- We explore the systemic contagion between carry trade portfolios and stock markets.
- A CoVaR model is adapted to measure systemic contagion which is defined as the tail risk conditional on extreme distress in other markets in excess of the norms of ordinary volatility-risk spillover.
- The evidence exhibits bilateral systemic contagion between carry-trade markets and stock markets in the U.S., European and Asia-Pacific regions.
- The systemic contagions are particularly severe during financial distress, like dot-com bubble and U.S. credit crisis.

Risk contagion between carry trade portfolios and stock markets had been explored in literatures, leaving inconsistent controversy. Instead of exploring ordinary return-volatility spillovers, this paper focuses on a systemic contagion, the tail risk conditional on extreme events in other markets. Using a conditional value-at-risk (CoVaR) model, we contribute to this line of literature by showing that there is bilateral systemic contagion between carry trades and stock markets in the U.S., European, or Asia-Pacific regions. Such a systemic contagion is particularly significant during the 2000-2001 dot-com bubble and 2007-2009 U.S. credit crisis.