94 Pages Posted: 8 Jun 2009 Last revised: 29 Aug 2010
Date Written: June 2009
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.
Suggested Citation: Suggested Citation
Farhi, Emmanuel and Fraiberger, Samuel P. and Gabaix, Xavier and Rancière, Romain G. and Verdelhan, Adrien, Crash Risk in Currency Markets (June 2009). NBER Working Paper No. w15062. Available at SSRN: https://ssrn.com/abstract=1415224