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- Title
RARE DISASTERS AND EXCHANGE RATES.
- Authors
FARHI, EMMANUEL; GABAIX, XAVIER
- Abstract
We propose a new model of exchange rates, based on the hypothesis that the possibility of rare but extreme disasters is an important determinant of risk premia in asset markets. The probability of world disasters as well as each country's exposure to these events is time-varying. This creates joint fluctuations in exchange rates, interest rates, options, and stock markets. The model accounts for a series of major puzzles in exchange rates: excess volatility and exchange rate disconnect, forward premium puzzle and large excess returns of the carry trade, and comovements between stocks and exchange rates. It also makes empirically successful signature predictions regarding the link between exchange rates and telltale signs of disaster risk in currency options.
- Subjects
FOREIGN exchange rates -- Government policy; DISASTERS; FOREIGN exchange policy; DISASTERS &; economics; INTEREST rates; STOCK exchanges; ECONOMICS; GOVERNMENT policy
- Publication
Quarterly Journal of Economics, 2016, Vol 131, Issue 1, p1
- ISSN
0033-5533
- Publication type
Article
- DOI
10.1093/qje/qjv040