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Financial amplification of foreign exchange risk premia

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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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  • Tobias Adrian & Erkko Etula & Jan J. J. Groen, 2010. "Financial amplification of foreign exchange risk premia," Staff Reports 461, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:461
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    Cited by:

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    2. Stefan Reitz & Dennis Umlandt, 2019. "Foreign Exchange Dealer Asset Pricing," Working Paper Series 2019-08, University of Trier, Research Group Quantitative Finance and Risk Analysis.
    3. Cheung, Yin-Wong & Wang, Wenhao, 2022. "Uncovered interest rate parity redux: Non-uniform effects," Journal of Empirical Finance, Elsevier, vol. 67(C), pages 133-151.
    4. Mikhail Chernov & Magnus Dahlquist & Lars Lochstoer, 2023. "Pricing Currency Risks," Journal of Finance, American Finance Association, vol. 78(2), pages 693-730, April.
    5. He, Zhiguo & Kelly, Bryan & Manela, Asaf, 2017. "Intermediary asset pricing: New evidence from many asset classes," Journal of Financial Economics, Elsevier, vol. 126(1), pages 1-35.
    6. Bernard Walley, 2015. "Macroeconomic sources of foreign exchange risk premium: evidence from South Africa," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 39(2), pages 382-395, April.
    7. Reitz, Stefan & Umlandt, Dennis, 2021. "Currency returns and FX dealer balance sheets," Journal of International Economics, Elsevier, vol. 133(C).
    8. Dennis Umlandt, 2020. "Likelihood-based Dynamic Asset Pricing: Learning Time-varying Risk Premia from Cross-Sectional Models," Working Paper Series 2020-06, University of Trier, Research Group Quantitative Finance and Risk Analysis.

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    Keywords

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