Crash Risk in Currency Returns

Mikhail Chernov, Jeremy Graveline and Irina Zviadadze

Journal of Financial and Quantitative Analysis, 2018, vol. 53, issue 1, 137-170

Abstract: We develop an empirical model of bilateral exchange rates. It includes normal shocks with stochastic variance and jumps in an exchange rate and in its variance. The probability of a jump in an exchange rate corresponding to depreciation (appreciation) of the U.S. dollar is increasing in the domestic (foreign) interest rate. The probability of a jump in variance is increasing in the variance only. Jumps in exchange rates are associated with announcements; jumps in variance are not. On average, jumps account for 25% of currency risk. The dollar carry index retains these features. Options suggest that jump risk is priced.

Date: 2018
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Working Paper: Crash Risk in Currency Returns (2012)
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