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Attention to the tail(s): global financial conditions and exchange rate risks

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  • Sokol, Andrej
  • Eguren-Martin, Fernando

Abstract

We document how the distribution of exchange rate returns responds to changes in global financial conditions. We measure global financial conditions as the common component of country-specific financial condition indices, computed consistently across a large panel of developed and emerging economies. Based on quantile regression results, we provide a characterisation and ranking of the tail behaviour of a large sample of currencies in response to a tightening of global financial conditions, corroborating (and quantifying) some of the prevailing narratives about safe haven and risky currencies. Our approach delivers a more nuanced picture than one based on standard OLS regression. We then carry out a portfolio sorting exercise to identify the macroeconomic fundamentals associated with such different tail behaviour, and find that currency portfolios sorted on the basis of net foreign asset positions, relative interest rates, current account balances and levels of international reserves display a higher likelihood of large losses in response to a tightening of global financial conditions. JEL Classification: F31, G15

Suggested Citation

  • Sokol, Andrej & Eguren-Martin, Fernando, 2020. "Attention to the tail(s): global financial conditions and exchange rate risks," Working Paper Series 2387, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202387
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    1. Simon Lloyd & Ed Manuel & Konstantin Panchev, 2024. "Foreign Vulnerabilities, Domestic Risks: The Global Drivers of GDP-at-Risk," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 72(1), pages 335-392, March.
    2. Ostry, D. A., 2023. "Tails of Foreign Exchange-at-Risk (FEaR)," Cambridge Working Papers in Economics 2343, Faculty of Economics, University of Cambridge.
    3. Aikman, David & Bridges, Jonathan & Hacioglu Hoke, Sinem & O’Neill, Cian & Raja, Akash, 2019. "Credit, capital and crises: a GDP-at-Risk approach," Bank of England working papers 824, Bank of England, revised 18 Oct 2019.
    4. Eguren-Martin, Fernando & O'Neill, Cian & Sokol, Andrej & von dem Berge, Lukas, 2020. "Capital flows-at-risk: push, pull and the role of policy," Bank of England working papers 881, Bank of England.
    5. Laurent Ferrara & Joseph Yapi, 2022. "Measuring exchange rate risks during periods of uncertainty," International Economics, CEPII research center, issue 170, pages 202-212.
    6. Busetto, Filippo, 2024. "Asymmetric expectations of monetary policy," Bank of England working papers 1058, Bank of England.
    7. Ostry, D. A., 2023. "Tails of Foreign Exchange-at-Risk (FEaR)," Janeway Institute Working Papers 2311, Faculty of Economics, University of Cambridge.
    8. Sona Benecka & Petr Polak, 2023. "Regional sentiment of Central European currencies in the global context," Occasional Publications - Chapters in Edited Volumes, in: CNB Global Economic Outlook - March 2023, pages 13-20, Czech National Bank.

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    More about this item

    Keywords

    exchange rates; financial conditions indices; global financial cycle; quantile regression; tail risks;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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