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Financial amplification of foreign exchange risk premia

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  • Tobias Adrian
  • Erkko Etula
  • Jan J. J. Groen

Abstract

Theories of systemic risk suggest that financial intermediaries’ balance-sheet constraints amplify fundamental shocks. We provide supporting evidence for such theories by decomposing the U.S. dollar risk premium into components associated with macroeconomic fundamentals and a component associated with financial intermediaries’ balance sheets. Relative to the benchmark model with only macroeconomic state variables, balance sheets amplify the U.S. dollar risk premium. We discuss applications to systemic risk monitoring.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 461.

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Date of creation: 2010
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Handle: RePEc:fip:fednsr:461

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Keywords: Systemic risk ; Intermediation (Finance) ; Foreign exchange ; Assets (Accounting);

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  14. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
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  25. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York.
  26. Charles Engel, 1996. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  27. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
  28. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2004. "Smoothing sudden stops," Journal of Economic Theory, Elsevier, vol. 119(1), pages 104-127, November.
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  32. Nijman, Theo E & Palm, Franz C & Wolff, Christian C P, 1993. "Premia in Forward Foreign Exchange as Unobserved Components: A Note," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(3), pages 361-65, July.
  33. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
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