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Country Size, Currency Unions, and International Asset Returns



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    • Tarek A. Hassan is with University of Chicago, NBER, and CEPR. I thank Philippe Aghion, John Y. Campbell, John Cochrane, Nicolas Coeurdacier, Emmanuel Farhi, Nicola Fuchs-Schündeln, Pierre-Olivier Gourinchas, Stéphane Guibaud, Elhanan Helpman, Thomas Mertens, Yves Nosbusch, Nathan Nunn, Helene Rey, Kenneth Rogoff, and Adrien Verdelhan for helpful comments. I also thank the workshop participants at Harvard Business School, Harvard University, Massachusetts Institute of Technology Sloan, Berkeley Haas, Kellogg Graduate School of Management, University of Chicago Booth, New York University Stern, Columbia Business School, Duke, Northwestern, London Business School, London School of Economics, Brown, Boston University, the World Bank, INSEAD, Institute for International Economic Studies Stockholm, the Federal Reserve Bank of Boston, the Austrian Central Bank, Universitat Pompeu Fabra/Centre de Recerca en Economia Internacional, University of Zurich/Institut fur Empirische Wirtschaftsforschung, the Society for Economic Dynamics annual meeting, and the CEPR European Summer Symposia in Financial Markets for valuable discussions. Special thanks also go to Dorothée Rouzet and Simon Rees.


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, indeed, differences in the size of economies explain a large fraction of the cross-sectional variation in currency returns. The data also support additional implications of the model: the introduction of a currency union lowers interest rates in participating countries, and stocks in the nontraded sector of larger economies pay lower expected returns.

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