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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. Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2013. "Pricing the term structure with linear regressions," Journal of Financial Economics, Elsevier, vol. 110(1), pages 110-138.
  2. Groen, Jan J.J. & Balakrishnan, Ravi, 2006. "Asset price based estimates of sterling exchange rate risk premia," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 71-92, February.
  3. Shin, Hyun Song & Adrian, Tobias, 2008. "Financial intermediaries, financial stability and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 287-334.
  4. Philippe Bacchetta & Cedric Tille & Eric van Wincoop, 2010. "Self-Fulfilling Risk Panics," Working Papers 282010, Hong Kong Institute for Monetary Research.
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  7. Ricardo Caballero & Arvind Krishnamurthy, 2000. "International and Domestic Collateral Constraints in a Model of Emerging Market Crises," NBER Working Papers 7971, National Bureau of Economic Research, Inc.
  8. repec:ner:tilbur:urn:nbn:nl:ui:12-3131741 is not listed on IDEAS
  9. Marianne Sensier & Dick van Dijk, 2004. "Testing for Volatility Changes in U.S. Macroeconomic Time Series," The Review of Economics and Statistics, MIT Press, vol. 86(3), pages 833-839, August.
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  12. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
  13. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," 2006 Meeting Papers 864, Society for Economic Dynamics.
  14. 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.
  15. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group.
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  17. 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.
  18. Erkko Etula, 2009. "Broker-dealer risk appetite and commodity returns," Staff Reports 406, Federal Reserve Bank of New York.
  19. Nick Roussanov & Adrien Verdelhan & Hanno Lustig, 2008. "Common Risk Factors in Currency Markets," 2008 Meeting Papers 711, Society for Economic Dynamics.
  20. Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
  21. Jan J.J. Groen & George Kapetanios, 2008. "Revisiting Useful Approaches to Data-Rich Macroeconomic Forecasting," Working Papers 624, Queen Mary University of London, School of Economics and Finance.
  22. Nijman, T.E. & Palm, F.C. & Wolff, C.C.P., 1991. "Premia in forward foreign exchange as unobserved components," Discussion Paper 1991-12, Tilburg University, Center for Economic Research.
  23. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  24. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers 311, Society for Economic Dynamics.
  25. 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.
  26. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  27. Philippe BACCHETTA & Cédric TILLE & Eric VAN WINCOOP, 2010. "Self-Fulfilling Risk Panics," Swiss Finance Institute Research Paper Series 10-32, Swiss Finance Institute.
  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. Boivin, Jean & Ng, Serena, 2006. "Are more data always better for factor analysis?," Journal of Econometrics, Elsevier, vol. 132(1), pages 169-194, May.
  30. 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.
  31. 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.
  32. Ricardo Caballero & Arvind Krishnamurthy, 2001. "Smoothing Sudden Stops," NBER Working Papers 8427, National Bureau of Economic Research, Inc.
  33. Korinek, Anton, 2011. "Systemic risk-taking: amplification effects, externalities, and regulatory responses," Working Paper Series 1345, European Central Bank.
  34. Robert Kollmann, 2010. "Banks and International Business Cycles," 2010 Meeting Papers 1058, Society for Economic Dynamics.
  35. Tobias Adrian & Emanuel Moench & Hyun Song Shin, 2010. "Financial intermediation, asset prices, and macroeconomic dynamics," Staff Reports 422, Federal Reserve Bank of New York.
  36. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
  37. 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.
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