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Crash Risk in Currency Markets

Emmanuel Farhi (), Samuel Fraiberger, Xavier Gabaix (), Romain Ranciere and Adrien Verdelhan

Working Paper from Harvard University OpenScholar

Abstract: Since the Fall of 2008, out-of-the money puts on high interest rate currencies have become significantly more expensive than out-of-the-money calls, suggesting a large crash risk of those currencies. To evaluate crash risk precisely, we propose a parsimonious structural model that includes both Gaussian and disaster risks and can be estimated even in samples that do not contain disasters. Estimating the model for the 1996 to 2014 sample period using monthly exchange rate spot, forward, and option data, we obtain a real-time index of the compensation for global disaster risk exposure. We find that disaster risk accounts for more than a third of the carry trade riskpremium in advanced countries over the period examined. The measure of disaster risk that we uncover in currencies proves to be an important factor in the cross-sectional and time-series variation of exchange rates, interest rates, and equity tail risk.

New Economics Papers: this item is included in nep-cta, nep-mon and nep-opm
Date: 2015-01
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Related works:
Working Paper: Crash Risk in Currency Market (2010)
Working Paper: Crash Risk in Currency Markets (2009) Downloads
Working Paper: Crash Risk in Currency Markets (2009) Downloads
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