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Funding liquidity constraints and the forward premium anomaly in a DSGE model

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  • Chu, Shiou-Yen

Abstract

This paper investigates the role of a funding liquidity constraint in the forward premium anomaly by developing a two-sector, two-agent dynamic stochastic general equilibrium (DSGE) model. We show that international consumption risks are not perfectly shared owing to the presence of a funding constraint and various discount factors. We explicitly specify a risk premium term and measure it in response to negative productivity shocks, policy shocks, and exchange rate shocks. The results indicate that these shocks, especially the policy shocks, widen the uncovered interest parity deviations to a great extent. Our research is compatible with the empirical evidence that funding illiquidity led to a significant uncovered interest parity violation during the 2008–2009 financial crisis.

Suggested Citation

  • Chu, Shiou-Yen, 2015. "Funding liquidity constraints and the forward premium anomaly in a DSGE model," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 76-89.
  • Handle: RePEc:eee:reveco:v:39:y:2015:i:c:p:76-89
    DOI: 10.1016/j.iref.2015.06.004
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    References listed on IDEAS

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    Keywords

    Carry trade; Collateralized loan; Nominal rigidities;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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