Crash Risk in Currency Markets

Xavier Gabaix, Adrien Verdelhan (), Rancière, Romain, Emmanuel Farhi and Samuel P. Fraiberger
Authors registered in the RePEc Author Service: Romain Rancière

No 7322, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: How much of carry trade excess returns can be explained by the presence of disaster risk? To answer this question, we propose a simple structural model that includes both Gaussian and disaster risk premia and can be estimated even in samples that do not contain disasters. The model points to a novel estimation procedure based on currency options with potentially different strikes. We implement this procedure on a large set of countries over the 1996-2008 period, forming portfolios of hedged and unhedged carry trade excess returns by sorting currencies based on their forward discounts. We find that disaster risk premia account for about 25% of expected carry trade excess returns in advanced countries.

Keywords: Carry trade; Currency crisis; Currency options; Disaster risk; exchange rate; Financial crisis (search for similar items in EconPapers)
JEL-codes: F3 F31 G01 G14 (search for similar items in EconPapers)
Date: 2009-06
New Economics Papers: this item is included in nep-ifn, nep-rmg and nep-upt
References: Add references at CitEc
Citations: View citations in EconPapers (88)

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Related works:
Working Paper: Crash Risk in Currency Markets (2015)
Working Paper: Crash Risk in Currency Market (2010)
Working Paper: Crash Risk in Currency Markets (2009)
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