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Are Different-Currency Assets Imperfect Substitutes?

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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Paper provided by Georgetown University, Department of Economics in its series Working Papers with number gueconwpa~00-00-05.

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Length: 40
Date of creation: 05 Aug 2000
Date of revision:
Handle: RePEc:geo:guwopa:gueconwpa~00-00-05
Contact details of provider: Postal: Georgetown University Department of Economics Washington, DC 20057-1036
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Fax: 202-687-6102
Web page: http://econ.georgetown.edu/
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