Country Size, Currency Unions, and International Asset Returns
73 Pages Posted: 26 Nov 2008 Last revised: 11 Jan 2013
There are 3 versions of this paper
Country Size, Currency Unions, and International Asset Returns
Country Size, Currency Unions, and International Asset Returns
Country Size, Currency Unions, and International Asset Returns
Date Written: December 22, 2012
Abstract
Differences in real interest rates across developed economies are puzzlingly large and persistent. I propose a simple explanation: Bonds issued in the currencies of larger economies are expensive because they insure against shocks that affect a larger fraction of the world economy. I show that differences in the size of economies indeed explain a large fraction of the cross-sectional variation in currency returns. The data also support a number of additional implications of the model: The introduction of a currency union lowers interest rates in participating countries and stocks in the non-traded sector of larger economies pay lower expected returns.
Keywords: International return differentials, country size, currency unions, uncovered interest parity, market segmentation
JEL Classification: F3, G0
Suggested Citation: Suggested Citation
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