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Currency returns and FX dealer balance sheets

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  • Reitz, Stefan
  • Umlandt, Dennis

Abstract

We show that excess returns to the carry trade can be interpreted as compensation for foreign exchange dealers’ capital risk. Given that the top market makers in foreign exchange are at the heart of the market's information aggregation process we also suggest that it is their marginal value of wealth which prices FX portfolio returns. Consistent with this hypothesis the empirical results show that shocks to the equity capital ratios of the top three foreign exchange dealers have explanatory power for the cross-sectional variation in expected currency returns, while those of the average dealer provide no substantial additional information.

Suggested Citation

  • Reitz, Stefan & Umlandt, Dennis, 2021. "Currency returns and FX dealer balance sheets," Journal of International Economics, Elsevier, vol. 133(C).
    • Handle: RePEc:eee:inecon:v:133:y:2021:i:c:s0022199621001215
    DOI: 10.1016/j.jinteco.2021.103541
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    More about this item

    Keywords

    Carry trades; FX dealers; Currency pricing; Balance sheet risk;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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