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on International Finance |
| By: | Tobias J. Moskowitz; Chase P. Ross; Sharon Y. Ross; Kaushik Vasudevan |
| Abstract: | Studies of intermediated arbitrage argue that bank balance sheets are an important consideration, yet little evidence exists on banks’ positioning in this context. Using confidential supervisory data (covering $25 trillion in daily notional exposures) we examine banks’ positions in connection with covered-interest parity (CIP) deviations. Exploiting cross-sectional variation in CIP deviations that have largely challenged existing theories, we document three novel forces that drive bases: 1) foreign safe asset scarcity, 2) market power and segmentation of banks specializing in different markets, and 3) concentration of demand. Our findings shed empirical light on the interplay of frictions influencing banks’ provision of dollar funding. |
| Keywords: | Basis; Covered-interest parity deviation; Foreign exchange; Safe assets |
| JEL: | F30 F31 F65 G10 G13 G15 G20 G23 |
| Date: | 2024–08–02 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-61 |
| By: | Martin Hodula; Jan Janku; Simona Malovana; Ngoc Anh Ngo |
| Abstract: | In our paper, we provide a review of the literature to identify the main transmission channels through which geopolitical risks (GPR) influence macro-financial stability. We begin by analyzing the existing measures of geopolitical tensions and uncertainty, showing that GPR impacts economic and financial uncertainty episodically, with significant but transient spikes during major geopolitical events. The review then identifies the two principal channels through which GPR affects macro-financial stability: the financial channel, operating through increased uncertainty and heightened risk aversion, leading to shifts in investment portfolio allocations and cross-border capital flows; and the real economy channel, impacting global trade, supply chains, and commodity markets. Using data from the past two to three decades, we provide graphical analyses that confirm the findings in the literature, highlighting the episodic nature of the impact of GPR. These insights underscore the need for policymakers and financial institutions to adopt event-specific approaches to effectively mitigate the adverse effects of geopolitical risks on economic and financial systems. |
| Keywords: | Financial stability, geopolitical risk, global economy, macro-financial impact, uncertainty shocks |
| JEL: | D80 E32 F44 F51 G2 G15 H56 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:cnb:wpaper:2024/8 |
| By: | Carolin Pflueger; Pierre Yared |
| Abstract: | We present a dynamic two-country model in which military spending, geopolitical risk, and government bond prices are jointly determined. The model is consistent with three empirical facts: hegemons have a funding advantage, this advantage rises with geopolitical tensions, and war losers suffer from higher debt devaluation than victors. Even though higher debt capacity increases the military and financial advantage of the exogenously stronger country, it also gives rise to equilibrium multiplicity and the possibility that the weaker country overwhelms the stronger country with support from financial markets. For intermediate debt capacity, transitional dynamics exhibit geopolitical hysteresis, with dominance determined by initial conditions, unless war is realized and induces a hegemonic transition. For high debt capacity, transitional dynamics exhibit geopolitical fragility, where bond market expectations drive unpredictable transitions in dominance, and hegemonic transitions occur even in the absence of war. |
| JEL: | F51 F65 G15 H56 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32775 |
| By: | Enrique G. Mendoza; Vincenzo Quadrini |
| Abstract: | Research has shown that the unilateral accumulation of international reserves by a country can improve its own macro-financial stability. However, we show that when many countries accumulate reserves, the induced general equilibrium effects weaken financial and macroeconomic stability, especially for countries that do not accumulate reserves. The issuance of public debt by advanced economies has the opposite effect. We derive these results from a two-region model where private defaultable debt has a productive use. Quantitative counterfactuals show that the surge in reserves (public debt) contributed to reduce (increase) world interest rates but also to increase (reduce) private leverage. This in turn increased (decreased) volatility in both emerging and advanced economies. |
| JEL: | F31 F41 F62 F65 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32810 |
| By: | Thordur Jonasson; Sheheryar Malik; Kay Chung; Mr. Michael G. Papaioannou |
| Abstract: | This paper presents some sound practices for foreign-currency risk management in developing countries and outlines instruments for managing sovereign debt portfolio currency exposures. Adoption of a debt management strategy with well-defined targets for foreign exchange risk is a critical element of public debt risk management. To this end, public debt managers often need to face with complex strategic and operational matters related to public debt hedging practices, including the use of derivatives. In this context, we highlight the main institutional challenges in the management of foreign exchange risk in sovereign debt portfolios and discuss the overall implementation of a foreign exchange risk-management strategy. |
| Date: | 2024–08–02 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/167 |
| By: | Charles Engel; Steve P.Y. Wu |
| Abstract: | Exchange-rate models fit very well for the U.S. dollar in the 21st century. A “standard” model that includes real interest rates and a measure of expected inflation for the U.S. and the foreign country, the U.S. comprehensive trade balance, and measures of global risk and liquidity demand is well-supported in the data for the U.S. against other G10 currencies. The monetary and non-monetary variables play equally important roles in explaining exchange rate movements. In the 1970s – early 1990s, the fit of the model was poor but the fit (as measured by t- and F-statistics, and R-squareds) has increased almost monotonically to the present day. We make the case that it is better monetary policy (inflation targeting) that has led to the improvement, as the scope for self-fulfilling expectations has disappeared. We provide a variety of evidence that links changes in monetary policy to the performance of the exchange-rate model. |
| JEL: | F31 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32808 |
| By: | Mikhail Mamonov; Christopher Parmeter; Artem Prokhorov |
| Abstract: | We study the impact of exchange rate volatility on cost efficiency and market structure in a cross-section of banks that have non-trivial exposures to foreign currency (FX) operations. We use unique data on quarterly revaluations of FX assets and liabilities (Revals) that Russian banks were reporting between 2004 Q1 and 2020 Q2. {\it First}, we document that Revals constitute the largest part of the banks' total costs, 26.5\% on average, with considerable variation across banks. {\it Second}, we find that stochastic estimates of cost efficiency are both severely downward biased -- by 30\% on average -- and generally not rank preserving when Revals are ignored, except for the tails, as our nonparametric copulas reveal. To ensure generalizability to other emerging market economies, we suggest a two-stage approach that does not rely on Revals but is able to shrink the downward bias in cost efficiency estimates by two-thirds. {\it Third}, we show that Revals are triggered by the mismatch in the banks' FX operations, which, in turn, is driven by household FX deposits and the instability of Ruble's exchange rate. {\it Fourth}, we find that the failure to account for Revals leads to the erroneous conclusion that the credit market is inefficient, which is driven by the upper quartile of the banks' distribution by total assets. Revals have considerable negative implications for financial stability which can be attenuated by the cross-border diversification of bank assets. |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2408.05688 |
| By: | Eguren-Martin, Fernando (SPX Capital); Kösem, Sevim (Bank of England); Maia, Guido (Centre for Macroeconomics and London School of Economics); Sokol, Andrej (Bloomberg LP) |
| Abstract: | We propose a novel approach to extract factors from large data sets that maximise covariation with the quantiles of a target distribution of interest. From the data underlying the Chicago Fed’s National Financial Conditions Index, we build targeted financial conditions indices for the quantiles of future US GDP growth. We show that our indices yield considerably better out-of-sample density forecasts than competing models, as well as insights on the importance of individual financial series for different quantiles. Notably, leverage indicators appear to co-move more with the median of the predictive distribution, while credit and risk indicators are more informative about downside risks. |
| Keywords: | Quantile regression; factor analysis; financial conditions indices; GDP-at-risk |
| JEL: | C32 C38 C53 C58 E37 E44 |
| Date: | 2024–08–06 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:1084 |
| By: | Kim, Taehoon (Korea Institute for Industrial Economics and Trade); Han, Jung Min (Korea Institute for Industrial Economics and Trade) |
| Abstract: | Recently, the behavior of the Korean won (KRW) versus the US dollar (USD) has exhibited significant volatility. In 2023 alone, the exchange rate fluctuated by more than KRW 10 on over 50 different days, which has made it difficult to predict future trends. In this paper, we explore how the volatility of the KRW-USD exchange rate has influenced the fortunes of domestic Korean manufacturers. Specifically, we quantitatively examine the impact of exchange rate fluctuations on corporate performance through an empirical analysis of exchange rate data and financial records, and use the findings of the analysis to determine implications for policy. For this work we utilized real effective exchange rate data from the Organisation for Economic Co-operation and Development (OECD) and Japanese think tank Research Institute of Economy, Trade, & Industry (RIETI). Real effective exchange rate data present exchange rate data in terms of a currency’s purchasing power relative to foreign currencies. A decrease in the real effective exchange rate implies a decrease in any given currency’s purchasing power compared to foreign currencies. Thank you for reading this abstract of a paper by the Korea Institute for Industrial Economics and Trade! We are South Korea's premier think tank studying the nexus where trade and industry intersect. |
| Keywords: | exchange rates; exchange rate risk; exchange rate volatility; manufacturing; manufacturing industry; industrial competitiveness; Korean won; US dollar; KRW-USD exchange rate; exchange rate fluctuations; corporate performance; Korea; KIET |
| JEL: | F30 F31 O24 |
| Date: | 2024–05–31 |
| URL: | https://d.repec.org/n?u=RePEc:ris:kieter:2024_015 |
| By: | Gita Gopinath; Josefin Meyer; Carmen Reinhart; Christoph Trebesch |
| Abstract: | Theory suggests that corporate and sovereign bonds are fundamentally different, also because sovereign debt has no bankruptcy mechanism and is hard to enforce. We show empirically that the two assets are more similar than you think, at least when it comes to high-yield bonds over the past 20 years. Based on rich new data we compare risky US corporate bonds (“junk” bonds) to risky emerging market sovereign bonds 2002-2021 (EMBI bonds). Investor experiences in these two asset classes were surprisingly aligned, with (i) similar average excess returns, (ii) similar average risk-return patterns (Sharpe ratios), (iii) a similar default frequency, and (iv) comparable haircuts. A notable difference is that the average default duration is higher for sovereigns. Furthermore, the time profile of bond returns and default events differs. One explanation is that the two markets co-move differently with domestic and global factors. US “junk” bond yields are more closely linked to US market conditions such as US stock market returns, US stock price volatility (VIX), US industrial production, or US monetary policy. |
| Keywords: | Sovereign debt and default, Default Risk, corporate bonds, corporate default, junkbonds, Chapter 11, crisis resolution |
| JEL: | G1 G3 H6 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:diw:diwwpp:dp2097 |