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Post by Sapphire Capital on Sept 23, 2009 8:36:37 GMT 4
Crash Risk in Currency Markets Emmanuel Farhi Harvard University - Department of Economics; National Bureau of Economic Research (NBER) Xavier Gabaix New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) Samuel P. Fraiberger New York University - Department of Economics 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 September 2009 NYU Working Paper No. FIN-09-007 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 which 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 on their forward discounts. We find that disaster risk premia account for about 25% of carry trade excess returns in advanced countries. papers.ssrn.com/sol3/Delivery.cfm/2451_28291.pdf?abstractid=1469126&mirid=1
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