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Crash Risk in Currency MarketsEmmanuel FarhiHarvard University - Department of Economics; National Bureau of Economic Research (NBER) Samuel P. FraibergerNew York University (NYU) - Department of Economics Xavier GabaixNew York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI) Romain RanciereInternational Monetary Fund (IMF) Adrien VerdelhanMassachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER) June 2009 NBER Working Paper No. w15062 Abstract: 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 working papers seriesDate posted: June 8, 2009Suggested CitationContact Information
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