73 Pages Posted: 26 Nov 2008 Last revised: 11 Jan 2013
Date Written: December 22, 2012
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
Hassan, Tarek A., Country Size, Currency Unions, and International Asset Returns (December 22, 2012). Journal of Finance, Forthcoming; AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1307287 or http://dx.doi.org/10.2139/ssrn.1307287
By Karen Lewis