Post by Farhi Fraiberger Gabaix on Aug 8, 2009 0:57:02 GMT 4
Crash Risk in Currency Markets
Emmanuel Farhi
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Samuel P. Fraiberger
New York University - Department of Economics
Xavier Gabaix
New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
Romain Ranciere
International Monetary Fund (IMF)
Adrien Verdelhan
Boston University - Department of Economics; National Bureau of Economic Research (NBER); Banque de France - Economic Study and Research Division
June 2009
CEPR Discussion Paper No. DP7322
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.
papers.ssrn.com/sol3/papers.cfm?abstract_id=1433918
Emmanuel Farhi
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Samuel P. Fraiberger
New York University - Department of Economics
Xavier Gabaix
New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
Romain Ranciere
International Monetary Fund (IMF)
Adrien Verdelhan
Boston University - Department of Economics; National Bureau of Economic Research (NBER); Banque de France - Economic Study and Research Division
June 2009
CEPR Discussion Paper No. DP7322
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.
papers.ssrn.com/sol3/papers.cfm?abstract_id=1433918