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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. 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.
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  35. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
  36. 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.
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