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Global liquidity and exchange rates

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Author Info
Tobias Adrian
Erkko Etula
Hyun Song Shin

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Abstract

We present evidence that fluctuations in the aggregate balance sheets of financial intermediaries forecast exchange rate returns - at weekly, monthly, and quarterly frequencies, both in and out of sample, and for a large set of countries. We estimate prices of risk using a cross-sectional, arbitrage-free asset pricing approach and show that balance sheets forecast exchange rates because of the latter's association with fluctuations in risk premia. We provide a rationale for an intertemporal equilibrium pricing theory in which intermediaries are subject to balance sheet constraints.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 361.

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Date of creation: 2009
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Handle: RePEc:fip:fednsr:361

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Related research
Keywords: Intermediation (Finance) ; Asset pricing ; Foreign exchange rates ; International finance ; Financial institutions ; Investment banking;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York. [Downloadable!]
  2. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May. [Downloadable!] (restricted)
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  3. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  4. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Groen, Jan J J, 2005. "Exchange Rate Predictability and Monetary Fundamentals in a Small Multi-country Panel," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 495-516, June.
  6. Charles Engel & Nelson C. Mark & Kenneth D. West, 2007. "Exchange Rate Models Are Not as Bad as You Think," NBER Working Papers 13318, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Charles Engel & Kenneth D. West, 2005. "Exchange Rates and Fundamentals," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 485-517, June.
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  8. Dumas, Bernard & Solnik, Bruno, 1995. " The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-79, June. [Downloadable!] (restricted)
  9. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March. [Downloadable!] (restricted)
  10. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, vol. 60(2), pages 615-647, 04. [Downloadable!] (restricted)
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  11. Joseph E. Gagnon & Alain P. Chaboud, 2007. "What can the data tell us about carry trades in Japanese yen?," International Finance Discussion Papers 899, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  12. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York. [Downloadable!]
  13. Tobias Adrian & Emanuel Moench, 2008. "Pricing the term structure with linear regressions," Staff Reports 340, Federal Reserve Bank of New York. [Downloadable!]
  14. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November. [Downloadable!] (restricted)
  15. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407. [Downloadable!] (restricted)
  16. Pierre-Olivier Gourinchas & Hélène Rey, 2007. "International Financial Adjustment," Journal of Political Economy, University of Chicago Press, vol. 115(4), pages 665-703, 08. [Downloadable!] (restricted)
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  1. Tobias Adrian & Hyun Song Shin, 2009. "Money, liquidity, and monetary policy," Staff Reports 360, Federal Reserve Bank of New York. [Downloadable!]
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This page was last updated on 2009-11-18.

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