nep-ifn New Economics Papers
on International Finance
Issue of 2017‒04‒02
four papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Varieties of Capital Flows: What Do We Know? By Eduardo Levy Yeyati; Jimena Zuniga
  2. The Currency Composition of International Portfolio Assets By Vahagn Galstyan; Caroline Mehigan; Rogelio Mercado
  3. Financial contagion with spillover effects: a multiplex network approach By Gustavo Peralta; Ricardo Crisóstomo
  4. Exchange Rate Policies at the Zero Lower Bound By Amador, Manuel; Bianchi, Javier; Bocola, Luigi; Perri, Fabrizio

  1. By: Eduardo Levy Yeyati; Jimena Zuniga
    Abstract: Capital flows have been the subject of key policy concern since the Brady plan launched the emerging markets asset class. Their massive volume, coupled with their volatile and procyclical nature, is often associated with a variety of financial and real risks: excess exchange rate volatility (gradual overvaluation and sharp corrections), dollar liquidity crunches, distressed asset sales, and crisis propensity. These risks have changed over time. Emerging market crises in the 1990s and 2000s were inherently driven by financial dollarization and balance sheet effects, the latter were intimately related with capital inflows in the form of growing foreign liability positions. But, now that financial dollarization has receded in the emerging market word (either through debt deleveraging or international reserve accumulation), the focus shifted to the macroeconomic effects of cross market flows, including extended periods of exchange rate misalignment and the amplification of business cycles in a context of large and persistent terms-of-trade shocks and global liquidity swings. Hence, the difficulty of evaluating capital flows based on data mostly from the 1990s and early 2000s. Hence, also, the emphasis on the recent empirical literature that revisits the issue with fresh data and an open mind. Capital flows cannot be addressed indistinctly or in isolation. Increasingly, academics and practitioners have flagged that different types of capital flows display different behaviors. Conventional wisdom tends to assume that, within portfolio flows, fixed income assets (bonds) are more harmful than equity in that they may introduce currency imbalances that may create deleterious balance sheet effects in the event of sharp exchange rate depreciation. By the same token, it is usually assumed that portfolio flows (including equity securities) are more volatile than foreign direct investment (FDI), because the latter is "sunk" in illiquid instruments that, precisely because of their illiquidity, are not prone to react to speculative motives or short-lived financial distress. However, even this simple order of riskiness deserves some reassessment. Within debt liabilities, a distinction needs to be made between foreign and local currency denominated instruments, at a time when foreign-currency instruments still dominate local-currency ones as emerging market investments; duration is another critical aspect to consider. Is equity "safer" than a long domestic currency bond from a macro prudential perspective?
    Date: 2015–05
  2. By: Vahagn Galstyan (Trinity College Dublin); Caroline Mehigan (OECD); Rogelio Mercado (Northumbria University)
    Abstract: In this paper, we empirically assess the importance of gravity-type variables and measures of macroeconomic and financial volatilities in explaining portfolio holdings denominated across the main global currencies: US dollar (USD), euro (EUR), Pound sterling (GBP), Japanese yen (JPY) and Swiss franc (CHF). Our findings underscore the importance of trade ties and common membership euro area. We also find that international positions co-move with the level of macroeconomic and financial uncertainty. Importantly, we identify heterogeneous patterns at a currency level.
    Keywords: currency composition, international portfolio assets, trade, volatility
    JEL: F31 F36 F41 G15
    Date: 2017–03
  3. By: Gustavo Peralta; Ricardo Crisóstomo
    Abstract: This paper presents a comprehensive model of financial contagion encompassing both direct and indirect transmission channels. We introduce direct contagion through a 2-layered multiplex network to account for the distinct dynamics resulting from collateralized and uncollateralized transactions. Moreover, the spillover effects of fire sales, haircut prociclicality and liquidity hoarding are specifically considered through indirect transmission channels. This framework allows us to analyze the determinants of systemic crisis and the resilience of different financial network configurations. Our first experiment demonstrates the benefits of counterparty diversification as a way of reducing systemic risk. The second experiment highlights the positive effect of higher initial capital and liquidity levels, while stressing the potentially counterproductive impact of rapidly increasing the minimum capital and liquidity ratios, particularly in times of stress. The third experiment examines the possibility of controlling the maximum haircut rates, although the impact of this measure is modest compared to other alternatives. Finally, our last experiment evidences the fundamental role played by fire sales and market liquidity in either leading or mitigating systemic crises. JEL Classification: C63, D85, G01, G18
    Keywords: multiplex networks, financial contagion, spillover effects, financial regulation, systemic risk, simulations
    Date: 2016–12
  4. By: Amador, Manuel (Federal Reserve Bank of Minneapolis); Bianchi, Javier (Federal Reserve Bank of Minneapolis); Bocola, Luigi (Northwestern University); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: We study how a monetary authority pursues an exchange rate objective in an environment that features a zero lower bound (ZLB) constraint on nominal interest rates and limits to international arbitrage. If the nominal interest rate that is consistent with interest rate parity is positive, the central bank can achieve its exchange rate objective by choosing that interest rate, a well-known result in international finance. However, if the rate consistent with parity is negative, pursuing an exchange rate objective necessarily results in zero nominal interest rates, deviations from parity, capital inflows, and welfare costs associated with the accumulation of foreign reserves by the central bank. In this latter case, all changes in external conditions that increase inflows of capital toward the country are detrimental, while policies such as negative nominal interest rates or capital controls can reduce the costs associated with an exchange rate policy. We provide a simple way of measuring these costs, and present empirical support for the key implications of our framework: when interest rates are close to zero, violations in covered interest parity are more likely, and those violations are associated with reserve accumulation by central banks.
    Keywords: Capital flows; CIP deviations; Currency pegs; Foreign exchange interventions; International reserves; Negative interest rates
    JEL: F31 F32 F41
    Date: 2017–03–16

This nep-ifn issue is ©2017 by Vimal Balasubramaniam. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.