Crash Risk in Currency Markets

94 Pages Posted: 8 Jun 2009  

Emmanuel Farhi

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

Samuel P. Fraiberger

Harvard University - Institute for Quantitative Social Sciences; Northeastern University - Network Science Institute; NYU Stern School of Business - IOMS Department

Xavier Gabaix

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

Romain G. Rancière

Paris School of Economics (PSE); International Monetary Fund (IMF)

Adrien Verdelhan

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

Multiple version iconThere are 3 versions of this paper

Date Written: June 2009

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.

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

Emmanuel Farhi (Contact Author)

Harvard University - Department of Economics ( email )

1875 Cambridge Street
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National Bureau of Economic Research (NBER) ( email )

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Samuel P. Fraiberger

Harvard University - Institute for Quantitative Social Sciences ( email )

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Northeastern University - Network Science Institute ( email )

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NYU Stern School of Business - IOMS Department ( email )

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Xavier Gabaix

New York University - Stern School of Business ( email )

Stern School of Business
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New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~xgabaix/

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI)

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Belgium

Romain G. Rancière

Paris School of Economics (PSE) ( email )

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Adrien Verdelhan

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
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