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on International Finance |
| By: | Karen K. Lewis; Edith Liu |
| Abstract: | When available financial securities allow investors to optimally diversify risk across countries, standard theory implies that exchange rates should reflect this behavior. However, exchange rates observed in the data deviate from these predictions. In this paper, we develop a framework to value the welfare costs of these exchange rate wedges, as disciplined by asset returns. This framework applies to a general class of asset pricing and exchange rate models. We further decompose the value of these wedges into components, showing that the ability of goods markets to respond to financial markets through exchange rate adjustment has significant implications for welfare. |
| JEL: | F30 F31 F41 G10 G15 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30422&r= |
| By: | John D. Burger; Francis E. Warnock; Veronica Cacdac Warnock |
| Abstract: | Latin American portfolio inflows show a strong tendency to revert to a natural level, KF*, over medium-run horizons. Deviations of actual flows from KF* provide policymakers with a real-time predictor of future flows, sudden stops and vulnerability to global shocks. Analysis of short-run deviations of flows from KF* reveals heterogeneous drivers: commodity prices for Brazil, Chile, and Mexico; risk tolerance for Argentina, Costa Rica, and Peru. |
| JEL: | F3 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30453&r= |
| By: | Michael B. Devereux; Steve Pak Yeung Wu |
| Abstract: | This paper studies the interaction between foreign exchange reserves and the currency composition of sovereign debt in emerging countries. Focusing on inflation targeting countries, we find that holdings of foreign reserves are associated with higher local currency sovereign debt, an exchange rate which is less sensitive to global shocks, and a lower exchange rate risk premium in local currency sovereign spreads. We rationalize these findings within a financially constrained model of a small open economy. The Sovereign values local currency debt as a hedge against endowment risk, but since the exchange rate tends to depreciate in times of global downturns, risk averse international investors charge an additional currency risk premium on this debt. When a country optimally uses foreign reserves to lean against the wind in response to global shocks, this dampens the response of the exchange rate, providing insurance for the global investor. By reducing the risk premium on local currency debt, foreign exchange reserves therefore facilitate a higher share of local currency debt in the sovereign portfolio. Quantitatively, we find the welfare benefits for the sovereign from optimal foreign reserves management can be very large. |
| JEL: | F30 F40 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30418&r= |
| By: | Andrada Bilan; Yalin Gündüz |
| Abstract: | We study the response of bond spreads to a liquidity supply shock in the credit default swap (CDS) market. Our identification strategy exploits the exogenous exit of a large dealer from the single-name CDS market as well as granular data on CDS transactions and bond portfolio holdings of German investors. Following the shock, CDS market liquidity declines and bond spreads increase, especially for the reference firms intermediated by the dealer. Individual portfolio data indicate hedging motives as a mechanism: as CDS insurance on their bond holdings becomes costlier, investors offload the bonds. Our results therefore show that frictions in derivative markets affect the underlying securities, which can raise firms' cost of capital. |
| Keywords: | Credit default swaps, dealer markets, bonds markets, credit risk, Depository Trust and Clearing Corporation (DTCC) |
| JEL: | G11 G18 G20 G28 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:snb:snbwpa:2022-09&r= |
| By: | Michelle Alexopoulos; Xinfen Han; Oleksiy Kryvtsov; Xu Zhang |
| Abstract: | We study soft information contained in congressional testimonies by the Federal Reserve Chairs and analyze its effects on financial markets. Using machine learning, we construct high-frequency measures of Fed Chairs' and Congress members' emotions expressed via their words, voice and face. Increases in the Chair's text-, voice-, or face-emotion indices during the testimony generally raise the S&P500 index and lower the VIX. Stock prices are particularly sensitive to both the members' questions and the Fed Chair's answers about issues directly related to monetary policy. These effects add up and propagate after the testimony, reaching magnitudes comparable to those after a policy rate cut. Our findings resonate with the view in psychology that communication is much more than words and underscore the need for a holistic approach to central bank communication. |
| Keywords: | Central bank communications, Financial markets, High-frequency identification, Facial emotion recognition, Vocal signal processing, Textual Analysis |
| JEL: | E52 E58 E71 |
| Date: | 2022–09–21 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-737&r= |
| By: | Diana Bonfim; Miguel A. Ferreira; Francisco Queiro; Sujiao (Emma) Zhao |
| Abstract: | We show that banks' lending exposure to rms with government procurement con- tracts can amplify the diabolic loop between sovereigns and banks. Using the scal austerity measures implemented during the 2010-2011 European sovereign debt crisis as a shock to government procurement, we nd that banks with higher exposure to these rms reduced lending signi cantly more than banks with lower exposure, controlling for rm-speci c credit demand. The reduction in credit supply is economically as important as the e ect of banks' sovereign debt holdings, and a ected both rms with and without government contracts. Firms with lending relationships with a ected banks experienced lower sales growth, assets growth, employment growth, and investment. This decrease in real economic activity is likely to reduce tax revenue, further amplifying the diabolic loop. |
| Keywords: | Credit supply, Government procurement, Investment, Employment, Financial crises, Bank-sovereign loop, Austerity |
| JEL: | G01 G20 G31 H57 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:unl:unlfep:wp644&r= |