Country Size, Currency Unions, and International Asset Returns
Tarek A. Hassan
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
December 22, 2012
Journal of Finance, Forthcoming
AFA 2011 Denver Meetings Paper
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.
Number of Pages in PDF File: 73
Keywords: International return differentials, country size, currency unions, uncovered interest parity, market segmentation
JEL Classification: F3, G0
Date posted: November 26, 2008 ; Last revised: January 11, 2013
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