Discussion paper

DP8991 Country Size, Currency Unions, and International Asset Returns

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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Citation

Hassan, T (2012), “DP8991 Country Size, Currency Unions, and International Asset Returns”, CEPR Press Discussion Paper No. 8991. https://cepr.org/publications/dp8991