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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. Matteo Maggiori, 2012. "Financial Intermediation, International Risk Sharing, and Reserve Currencies," 2012 Meeting Papers 146, Society for Economic Dynamics.
  2. Ian Martin, 2011. "The Forward Premium Puzzle in a Two-Country World," NBER Working Papers 17564, National Bureau of Economic Research, Inc.
  3. 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.

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