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http://ssrn.com/abstract=1397668
 
 

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Crash Risk in Currency Markets


Emmanuel Farhi


Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Samuel P. Fraiberger


New York University (NYU) - Department of Economics

Xavier Gabaix


New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Romain Ranciere


International Monetary Fund (IMF)

Adrien Verdelhan


Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

June 8, 2014

NYU Working Paper No. FIN-09-007

Abstract:     
Out-of-the-money currency options point to large expected exchange rate depreciations for high interest rate currencies, suggesting that disaster risk is priced in currency markets. To study the price of disaster risk, 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 2013 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 a third of average currency carry trade excess returns in advanced countries over the period examined. We document that after the Fall of 2008, options prices exhibit a sharp increase in tail risk, similar to the emergence of the smirk in equity options after the 1987 crash.

Number of Pages in PDF File: 62

Keywords: Exchange Rates, Disaster Risk, Currency Options

JEL Classification: E44, F31, G12

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Date posted: May 7, 2009 ; Last revised: June 9, 2014

Suggested Citation

Farhi, Emmanuel and Fraiberger, Samuel P. and Gabaix, Xavier and Ranciere, Romain and Verdelhan, Adrien, Crash Risk in Currency Markets (June 8, 2014). NYU Working Paper No. FIN-09-007 . Available at SSRN: http://ssrn.com/abstract=1397668 or http://dx.doi.org/10.2139/ssrn.1397668

Contact Information

Emmanuel Farhi
Harvard University - Department of Economics ( email )
1875 Cambridge Street
Cambridge, MA 02138
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Samuel P. Fraiberger
New York University (NYU) - Department of Economics ( email )
269 Mercer Street, 7th Floor
New York, NY 10011
United States
Xavier Gabaix
New York University - Stern School of Business ( email )
Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States
HOME PAGE: http://pages.stern.nyu.edu/~xgabaix/
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Romain Ranciere
International Monetary Fund (IMF) ( email )
700 19th Street NW
Washington, DC 20431
United States
Adrien Verdelhan (Contact Author)
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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