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Country Size, Currency Unions, and International Asset Returns

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  • Hassan, Tarek

Abstract

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8991.

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Date of creation: May 2012
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Handle: RePEc:cpr:ceprdp:8991

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Keywords: carry trade; country size; currency unions; International return differentials; market segmentation; uncovered interest parity;

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References

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Citations

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Cited by:
  1. Gorea, Denis & Radev, Deyan, 2014. "The euro area sovereign debt crisis: Can contagion spread from the periphery to the core?," International Review of Economics & Finance, Elsevier, vol. 30(C), pages 78-100.
  2. Pierre-Olivier Gourinchas & Helene Rey & Nicolas Govillot, 2010. "Exorbitant Privilege and Exorbitant Duty," IMES Discussion Paper Series 10-E-20, Institute for Monetary and Economic Studies, Bank of Japan.
  3. Ian Martin, 2011. "The Forward Premium Puzzle in a Two-Country World," NBER Working Papers 17564, National Bureau of Economic Research, Inc.
  4. Tarek A. Hassan & Rui C. Mano, 2014. "Forward and Spot Exchange Rates in a Multi-currency World," NBER Working Papers 20294, National Bureau of Economic Research, Inc.
  5. Pierre-Olivier Gourinchas & Hélène Rey, 2013. "External Adjustment, Global Imbalances and Valuation Effects," NBER Working Papers 19240, National Bureau of Economic Research, Inc.
  6. Matteo Maggiori, 2012. "Financial Intermediation, International Risk Sharing, and Reserve Currencies," 2012 Meeting Papers 146, Society for Economic Dynamics.

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