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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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  • Hassan, Tarek, 2012. "Country Size, Currency Unions, and International Asset Returns," CEPR Discussion Papers 8991, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8991
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    Cited by:

    1. Gourinchas, Pierre-Olivier & Rey, Hélène, 2013. "External Adjustment, Global Imbalances and Valuation Effects," CEPR Discussion Papers 9566, C.E.P.R. Discussion Papers.
    2. Rogoff, Kenneth S. & Tashiro, Takeshi, 2015. "Japan’s exorbitant privilege," Journal of the Japanese and International Economies, Elsevier, vol. 35(C), pages 43-61.
    3. 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.
    4. Tarek A. Hassan & Thomas M. Mertens & Tony Zhang, 2016. "Not So Disconnected: Exchange Rates and the Capital Stock," NBER Chapters,in: NBER International Seminar on Macroeconomics 2015 National Bureau of Economic Research, Inc.
    5. Thomas Nitschka, 2016. "Risk premia on Swiss government bonds and sectoral stock indexes during international crises:," Aussenwirtschaft, University of St. Gallen, School of Economics and Political Science, Swiss Institute for International Economics and Applied Economics Research, vol. 67(02), pages 51-67, August.
    6. repec:eee:jimfin:v:74:y:2017:i:c:p:187-208 is not listed on IDEAS
    7. Weithing Zhang & Thomas Mertens & Tarek Hassan, 2014. "Currency Manipulation," 2014 Meeting Papers 401, Society for Economic Dynamics.
    8. Stijn Claessens & M. Ayhan Kose, 2017. "Asset prices and macroeconomic outcomes: A survey," CAMA Working Papers 2017-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    9. 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.
    10. Yu, Changhua, 2015. "Evaluating international financial integration in a center-periphery economy," Journal of International Economics, Elsevier, vol. 95(1), pages 129-144.
    11. Gita Gopinath & Jeremy C. Stein, 2018. "Banking, Trade, and the making of a Dominant Currency," NBER Working Papers 24485, National Bureau of Economic Research, Inc.
    12. Hoffmann, Mathias & Studer-Suter, Rahel, 2017. "Systematic consumption risk in currency returns," Journal of International Money and Finance, Elsevier, vol. 74(C), pages 187-208.
    13. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 28(11), pages 3073-3108.
    14. Hanno Lustig & Robert J. Richmond, 2017. "Gravity in FX R-Squared: Understanding the Factor Structure in Exchange Rates," NBER Working Papers 23773, National Bureau of Economic Research, Inc.
    15. Ian Martin, 2011. "The Forward Premium Puzzle in a Two-Country World," NBER Working Papers 17564, National Bureau of Economic Research, Inc.
    16. Bris, Arturo & Koskinen, Yrjö & Nilsson, Mattias, 2014. "The euro and corporate financing before the crisis," Journal of Financial Economics, Elsevier, vol. 114(3), pages 554-575.
    17. Kremens, Lukas & Martin, Ian, 2017. "The Quanto Theory of Exchange Rates," CEPR Discussion Papers 11970, C.E.P.R. Discussion Papers.
    18. Victoria Dobrynskaya, 2015. "Currency Exposure to Downside Risk: Which Fundamentals Matter?," Review of International Economics, Wiley Blackwell, vol. 23(2), pages 345-360, May.
    19. Lorenzo Garlappi & Jack Favilukis, 2015. "The Carry Trade and UIP when Markets are Incomplete," 2015 Meeting Papers 242, Society for Economic Dynamics.
    20. Ready, Robert & Roussanov, Nikolai & Ward, Colin, 2017. "After the tide: Commodity currencies and global trade," Journal of Monetary Economics, Elsevier, vol. 85(C), pages 69-86.
    21. repec:eee:jfinec:v:127:y:2018:i:2:p:197-225 is not listed on IDEAS
    22. Robert Ready & Mariano Croce & Federico Gavazzoni & Riccardo Colacito, 2016. "Currency Risk Factors in a Recursive Multi-Country Economy," 2016 Meeting Papers 297, Society for Economic Dynamics.
    23. Yang Liu & Mariano Croce & Ivan Shaliastovich & Ric Colacito, 2016. "Volatility Risk Pass-Through," 2016 Meeting Papers 135, Society for Economic Dynamics.
    24. 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.

    More about this item

    Keywords

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

    JEL classification:

    • F3 - International Economics - - International Finance
    • G0 - Financial Economics - - General

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