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U.S. Dollar Risk Premiums and Capital Flows

  • Ravi Balakrishnan
  • Volodymyr Tulin
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    This paper sheds light on the attractiveness of U.S. assets by studying dollar risk premiums, calculated using Consensus exchange rate forecasts, and linking them to bilateral capital flows. The paper finds that the presence of negative dollar risk premiums (i.e. expectations of a dollar depreciation net of interest rate effects) amid record capital inflows could suggest that investors may favor U.S. assets for structural reasons. One possible explanation could be that the Asian crisis created a large pool of savings searching for relatively riskless investment opportunities, which were provided by deep, liquid, and innovative U.S. financial markets with robust investor protection. Moreover, the continued attractiveness of U.S. financial markets to European investors suggests that they offer a large array of assets, with different risk/return characteristics, that facilitate the structuring of diversified investment portfolios. Looking forward, this suggests that the allocative efficiency of U.S. financial markets could mitigate risks of a disorderly unwinding of global current account imbalances.

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    Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/160.

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    Length: 27
    Date of creation: 01 Jun 2006
    Date of revision:
    Handle: RePEc:imf:imfwpa:06/160
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    1. Blanchard, Olivier & Giavazzi, Francesco & Sá, Filipa, 2005. "The US Current Account and the Dollar," CEPR Discussion Papers 4888, C.E.P.R. Discussion Papers.
    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. Chinn, Menzie & Frankel, Jeffrey, 1994. "Patterns in Exchange Rate Forecasts for Twenty-five Currencies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(4), pages 759-70, November.
    4. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June.
    5. Ayuso, Juan & Restoy, Fernando, 1996. "Interest rate parity and foreign exchange risk premia in the ERM," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 369-382, June.
    6. Martin Lettau & Sydney Ludvigson, 1999. "Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying," Staff Reports 93, Federal Reserve Bank of New York.
    7. Kenneth Rogoff & William Brainard & George Perry, . "Global Current Account Imbalances and Exchange Rate Adjustments," Working Paper 33687, Harvard University OpenScholar.
    8. Caballero, Ricardo J & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2006. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," Center for International and Development Economics Research, Working Paper Series qt7xc0g8mm, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
    9. Charles P. Thomas, 2006. "The Performance of International Equity Portfolios," The Institute for International Integration Studies Discussion Paper Series iiisdp162, IIIS.
    10. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
    11. Robin Brooks & Torsten Sløk & Manmohan S. Kumar & Hali J. Edison, 2001. "Exchange Rates and Capital Flows," IMF Working Papers 01/190, International Monetary Fund.
    12. Charles P. Thomas & Francis E. Warnock & Jon Wongswan, 2006. "The Performance of International Equity Portfolios," NBER Working Papers 12346, National Bureau of Economic Research, Inc.
    13. Joseph W. Gruber & Steven B. Kamin, 2005. "Explaining the global pattern of current account imbalances," International Finance Discussion Papers 846, Board of Governors of the Federal Reserve System (U.S.).
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