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Are Different-Currency Assets Imperfect Substitutes?

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This paper provides a new test for whether different-currency assets are imperfect substitutes. Past work on imperfect substitutability in foreign exchange falls into two groups: (1) tests using measures of asset supply and (2) tests using measures of central-bank asset demand. We address the demand side, but we use a broad measure of public demand rather than focusing on demand by central banks. Under floating rates, changing public demand has no direct effect on monetary fundamentals, current or future. This provides an opportunity to test for price effects from imperfect substitutability. We develop and estimate a micro portfolio balance model that has both Walrasian and microstructure features. Price effects from imperfect substitutability are clearly present: the immediate price impact of public trades is 0.44 percent per $1 billion (of which, about 80 percent persists indefinitely). This estimate is applicable to intervention trades in the special case when they are indistinguishable from private trades (i.e., when interventions are sterilized, anonymous, and provide no monetary-policy signal).

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  • Martin D. D. Evans & Richard K. Lyons, 2000. "Are Different-Currency Assets Imperfect Substitutes?," Working Papers gueconwpa~00-00-05, Georgetown University, Department of Economics.
    • Handle: RePEc:geo:guwopa:gueconwpa~00-00-05
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    2. Pierre Salmon, 2003. "The assignment of powers in an open-ended European Union," Post-Print hal-00445601, HAL.
    3. Pasquariello, Paolo, 2007. "Informative trading or just costly noise? An analysis of Central Bank interventions," Journal of Financial Markets, Elsevier, vol. 10(2), pages 107-143, May.
    4. Lukas Menkhoff, 2010. "High‐Frequency Analysis Of Foreign Exchange Interventions: What Do We Learn?," Journal of Economic Surveys, Wiley Blackwell, vol. 24(1), pages 85-112, February.
    5. Wang, Junfeng & Xu, Xiaoya & Wang, Shimeng & He, Shutong & He, Pan, 2021. "Heterogeneous effects of COVID-19 lockdown measures on air quality in Northern China," Applied Energy, Elsevier, vol. 282(PA).
    6. Lukas Menkhoff, 2013. "Foreign Exchange Intervention in Emerging Markets: A Survey of Empirical Studies," The World Economy, Wiley Blackwell, vol. 36(9), pages 1187-1208, September.
    7. Wu, Wenqing & Zhu, Dongyang & Liu, Wenyi & Wu, Chia-Huei, 2022. "Empirical research on smart city construction and public health under information and communications technology," Socio-Economic Planning Sciences, Elsevier, vol. 80(C).
    8. Evans, Richard W., 2012. "Is openness inflationary? Policy commitment and imperfect competition," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 1095-1110.
    9. Raddatz, Claudio & Schmukler, Sergio L. & Williams, Tomás, 2017. "International asset allocations and capital flows: The benchmark effect," Journal of International Economics, Elsevier, vol. 108(C), pages 413-430.
    10. Michael D. Bordo & Owen F. Humpage & Anna J. Schwartz, 2012. "The Federal Reserve as an Informed Foreign Exchange Trader: 1973–1995," International Journal of Central Banking, International Journal of Central Banking, vol. 8(1), pages 127-160, March.
    11. Michael D. Bordo & Owen F. Humpage & Anna J. Schwartz, 2016. "On the Evolution of US Foreign-Exchange-Market Intervention: Thesis, Theory, and Institutions," NBER Chapters, in: Strained Relations: US Foreign-Exchange Operations and Monetary Policy in the Twentieth Century, pages 1-26, National Bureau of Economic Research, Inc.
    12. Timo Wollmershäuser, 2003. "Sterilised foreign exchange market interventions - a controversial monetary instrument," ifo Schnelldienst, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 56(19), pages 34-44, October.
    13. Josh Ederington & Arik Levinson & Jenny Minier, 2005. "Footloose and Pollution-Free," The Review of Economics and Statistics, MIT Press, vol. 87(1), pages 92-99, February.
    14. Peter Bofinger & Timo Wollmershäuser, 2003. "Managed Floating as a Monetary Policy Strategy," Economic Change and Restructuring, Springer, vol. 36(2), pages 81-109, June.
    15. M. Kayalica & Sajal Lahiri, 2005. "Strategic Environmental Policies in the Presence of Foreign Direct Investment," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 30(1), pages 1-21, January.
    16. Fatum, Rasmus, 2015. "Foreign exchange intervention when interest rates are zero: Does the portfolio balance channel matter after all?," Journal of International Money and Finance, Elsevier, vol. 57(C), pages 185-199.
    17. Charumathi B & Mangaiyarkarasi T, 2023. "Effect of the COVID-19 Pandemic on CO2 Emissions in India," Energy RESEARCH LETTERS, Asia-Pacific Applied Economics Association, vol. 3(4), pages 1-5.
    18. Richard W. Evans, 2007. "Is openness inflationary? Imperfect competition and monetary market power," Globalization Institute Working Papers 01, Federal Reserve Bank of Dallas.
    19. Taylor, Mark P. & Schmidt, Markus & Reitz, Stefan, 2007. "End-user order flow and exchange rate dynamics," Discussion Paper Series 1: Economic Studies 2007,05, Deutsche Bundesbank.

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