The U.S. Dollar Safety Premium
43 Pages Posted: 15 Mar 2012
Date Written: November 31, 2011
I show that the US dollar earns a safety premium versus a basket of foreign currencies and that this premium is particularly high in times of global ﬁnancial stress. These ﬁndings support the view that the dollar acts as the reserve currency for the international monetary system and that it is a natural safe haven in times of crisis, when a global ﬂight to quality toward the reserve currency takes place. During such episodes, investors are willing to earn negative expected returns as compensation for holding safe dollars. I estimate the time varying dollar safety premium by using instrumental variable techniques to condition information down.
Keywords: exchange rates, reserve currency, exorbitant privilege, currency returns, time-varying risk
JEL Classification: F31, G12, G15
Suggested Citation: Suggested Citation