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on International Finance |
| By: | Brauning, Falk (Federal Reserve Bank of Boston); Ivashina, Victoria (Harvard Business School) |
| Abstract: | Global banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often denominated in different currencies. This leads to a foreign exchange (FX) exposure that banks need to hedge. If cross‐currency flows are large, the hedging cost increases, diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest interest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity. |
| Keywords: | global banks; monetary policy transmission; cross‐border lending |
| JEL: | E44 E52 F36 G15 G21 G28 |
| Date: | 2016–12–23 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbwp:17-5&r=ifn |
| By: | Kanda Naknoi (University of Connecticut); Hanno Lustig (Stanford University); YiLi Chien (Federal Reserve Bank of St. Louis) |
| Abstract: | Empirical work on asset prices suggests that pricing kernels have to be almost perfectly correlated across countries. If they are not, real exchange rates are too smooth to be consistent with high Sharpe ratios in asset markets. However, the cross-country correlation of macro fundamentals is far from perfect. We reconcile these empirical facts in a two-country stochastic growth model with heterogeneous household portfolios. A large fraction of households either hold low risk portfolios and/or do not adjust their portfolio optimally, and these households drive down the cross-country correlation in aggregate consumption. Only a small fraction of households participate in international risk sharing by frequently trading domestic and foreign equities. These active traders are the marginal investors, who impute the almost perfect correlation in pricing kernels. In our calibrated economy, we show that this mechanism can quantitatively account for the excess smoothness of exchange rates in the presence of highly volatile stochastic discount factors. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:214&r=ifn |