Discussion Paper Details

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Title: Country Size, Currency Unions, and International Asset Returns

Author(s): Tarek Alexander Hassan

Publication Date: May 2012

Keyword(s): carry trade, country size, currency unions, International return differentials, market segmentation and uncovered interest parity

Programme Area(s): Financial Economics, International Macroeconomics and International Trade and Regional Economics

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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Bibliographic Reference

Hassan, T. 2012. 'Country Size, Currency Unions, and International Asset Returns'. London, Centre for Economic Policy Research.