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Financial amplification of foreign exchange risk premia

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

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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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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  1. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York.
  2. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347 National Bureau of Economic Research, Inc.
  3. Bacchetta, Philippe & Tille, Cédric & Wincoop, Eric, 2011. "Self-Fulfilling Risk Panics," Working Papers 2011-003, Banco Central de Reserva del Perú.
  4. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
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  7. Mark, Nelson C., 1985. "On time varying risk premia in the foreign exchange market: An econometric analysis," Journal of Monetary Economics, Elsevier, vol. 16(1), pages 3-18, July.
  8. Jean Boivin & Serena Ng, 2003. "Are More Data Always Better for Factor Analysis?," NBER Working Papers 9829, National Bureau of Economic Research, Inc.
  9. Tobias Adrian & Emanuel Moench, 2008. "Pricing the term structure with linear regressions," Staff Reports 340, Federal Reserve Bank of New York.
  10. Jan J. J. Groen & George Kapetanios, 2008. "Revisiting useful approaches to data-rich macroeconomic forecasting," Staff Reports 327, Federal Reserve Bank of New York.
  11. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
  12. 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.
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  14. Stock, James H & Watson, Mark W, 2002. "Macroeconomic Forecasting Using Diffusion Indexes," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 147-62, April.
  15. Robert Kollmann, 2010. "Banks and International Business Cycles," 2010 Meeting Papers 1058, Society for Economic Dynamics.
  16. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  17. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
  18. Philippe BACCHETTA & Cédric TILLE & Eric VAN WINCOOP, 2010. "Self-Fulfilling Risk Panics," Swiss Finance Institute Research Paper Series 10-32, Swiss Finance Institute.
  19. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
  20. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2004. "Smoothing sudden stops," Journal of Economic Theory, Elsevier, vol. 119(1), pages 104-127, November.
  21. Bams, Dennis & Walkowiak, Kim & Wolff, Christian C. P., 2004. "More evidence on the dollar risk premium in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 23(2), pages 271-282, March.
  22. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," NBER Working Papers 12489, National Bureau of Economic Research, Inc.
  23. Groen, Jan J J & Mumtaz, Haroon, 2008. "Investigating the structural stability of the Phillips curve relationship," Bank of England working papers 350, Bank of England.
  24. Erkko Etula, 2009. "Broker-dealer risk appetite and commodity returns," Staff Reports 406, Federal Reserve Bank of New York.
  25. 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.
  26. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
  27. Jan J J Groen & Ravi Balakrishnan, 2005. "Asset price based estimates of sterling exchange rate risk premia," Bank of England working papers 250, Bank of England.
  28. Ronald Mahieu & Peter Schotman, 1994. "Neglected Common Factors in Exchange Rate Volatility," CEPR Financial Markets Paper 0041, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ..
  29. Nijman, T.E. & Palm, F.C. & Wolff, C.C.P., 1993. "Premia in forward foreign exchange as unobserved components," Other publications TiSEM 23782b7b-2146-4381-8cf9-4, Tilburg University, School of Economics and Management.
  30. Hyun Song Shin & Emanuel Moench & Tobias Adrian, 2010. "Financial Intermediation, Asset Prices, and Macroeconomic Dynamics," 2010 Meeting Papers 297, Society for Economic Dynamics.
  31. Wolff, Christian C P, 1987. " Forward Foreign Exchange Rates, Expected Spot Rates, and Premia: A Signal-Extraction Approach," Journal of Finance, American Finance Association, vol. 42(2), pages 395-406, June.
  32. M Sensier & D van Dijk, 2003. "Testing for Volatility Changes in US Macroeconomic Time Series," Centre for Growth and Business Cycle Research Discussion Paper Series 36, Economics, The Univeristy of Manchester.
  33. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
  34. Jushan Bai, 2003. "Inferential Theory for Factor Models of Large Dimensions," Econometrica, Econometric Society, vol. 71(1), pages 135-171, January.
  35. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers 311, Society for Economic Dynamics.
  36. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
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