We quantify crash risk in currency returns. To accomplish this task, we develop and estimate an
empirical model of exchange rate dynamics using daily data for four currencies relative to the US
dollar: the Australian dollar, the British pound, the Swiss franc, and the Japanese yen. The model
includes (i) normal shocks with stochastic variance, (ii) jumps up and down in the exchange rate,
and (iii) jumps in the variance. We identify these components using data on exchange rates and
at-the-money implied variances. We find that crash risk is time-varying. The probability of an
upward (downward) jump in the exchange rate, associated with depreciation (appreciation) of the
US dollar, is increasing in the domestic (foreign) interest rate. The probability of jumps in variance
is increasing in the variance but is not related to interest rates. Many of the jumps in exchange
rates are associated with macroeconomic and political news, but jumps in variance are not. On
average, jumps account for 25% (and can be as high as 40%) of total currency risk, as measured by
the entropy of exchange rate changes, over horizons of one to three months. Preliminary analysis
suggests that these properties of currency returns correspond to observed option smiles and that
jump risk is priced.