Crash Risk in Currency Markets
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Samuel P. Fraiberger
New York University (NYU) - Department of Economics
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 G. Rancière
Paris School of Economics (PSE); International Monetary Fund (IMF)
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
NBER Working Paper No. w15062
Since the fall of 2008, option smiles have been clearly asymmetric: out-of-the-money currency options point to large expected exchange rate depreciations (appreciations) for high (low) interest rate currencies, suggesting that disaster risk is priced in currency markets. To study the price of disaster risk, we propose a simple structural model that includes both Gaussian and disaster risk and can be estimated even in samples that do not contain disasters. Estimating the model over the 1996 to 2011 period using exchange rate spot, forward, and option data, we obtain a real-time index of world disaster risk premia. We find that disaster risk accounts for more than a third of currency risk premia in advanced countries over the period.
Number of Pages in PDF File: 94
Date posted: June 8, 2009
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