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on International Finance |
| By: | Patrick Pintus (InSHS - CNRS - Institut des Sciences Humaines et Sociales - CNRS - INS1640, GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique - AMU - Aix Marseille Université - EHESS - École des hautes études en sciences sociales); Yi Wen (Federal Reserve Bank of St. Louis, School of Economics and Management, Tsinghua University); Xiaochuan Xing (Department of Economics, Yale University) |
| Abstract: | This paper stresses a new channel through which global financial linkages contribute to the co-movement in economic activity across countries. We show in a two-country setting with borrowing constraints that international credit markets are subject to self-fulfilling variations in the world real interest rate. Those expectation-driven changes in the borrowing cost in turn act as global shocks that induce strong cross-country co-movements in both financial and real variables (such as asset prices, GDP, consumption, investment and employment). When firms around the world benefit from unexpectedly low debt repayments, they borrow and invest more, which leads to excessive supply of collateral and of loanable funds at a low interest rate, thus fueling a boom in both home and foreign economies. As a consequence, business cycles are synchronized internationally. Such a stylized model thus offers one way to rationalize both the existence of a world business-cycle component, documented by recent empirical studies through dynamic factor analysis, and the factor’s intimate link to global financial markets. |
| Keywords: | world interest rate,international co-movement,self-fulfilling equilibria |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01797029&r=ifn |
| By: | Krogstrup, Signe; Tille, Cédric |
| Abstract: | The literature on drivers of capital flows stresses the prominent role of global financial factors. Recent empirical work, however, highlights how this role varies across countries and time, and this heterogeneity is not well understood. We revisit this question by focusing on financial intermediaries' funding flows in different currencies. A portfolio model shows that the sign and magnitude of the response of foreign currency funding flows to global risk factors depend on the financial intermediary's pre-existing currency exposure. Analysis of data on European banks' aggregate balance sheets lends support to the model predictions, especially in countries outside the euro area. |
| Keywords: | Capital Flows; cross-border transmission of shocks; currency mismatch; European bank balance sheets.; push factors; Spillovers |
| JEL: | F32 F34 F36 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12933&r=ifn |
| By: | Krishnamurthy, Arvind (Reserve Bank of India); Archarya, Viral V. (Stanford University) |
| Abstract: | We examine theoretically the role of reserves management and macro-prudential capital controls as ex-post and ex-ante safeguards, respectively, against sudden stops, and argue that these measures are complements rather than substitutes. Absent capital controls, reserves to be deployed ex post are partially undone ex ante by short-term capital flows, a form of moral hazard from the insurance provided by reserves in sudden stops. Ex ante capital controls offset this distortion and thereby increase the benefit of holding reserves. Thus, these instruments are complements. With foreign investment flows into both domestic and external borrowing markets, capital controls need to account for the possibility of regulatory arbitrage between the markets. Through the lens of the model, we analyze movements in foreign reserves, external debt, and the range of capital controls being employed by one large emerging market, viz. India. |
| JEL: | E44 G12 G2 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3646&r=ifn |
| By: | Jiang, Zhengyang (Stanford University); Krishnamurthy, Arvind (Stanford University); Lustig, Hanno (Stanford University) |
| Abstract: | The convenience yield that foreign investors derive from holding U.S. Treasurys causes a failure of Covered Interest Rate Parity by driving a wedge between the yield on the foreign bonds and the currency-hedged yield on the U.S. Treasury bonds. Even before the 2007-2009 financial crisis, the Treasury-based dollar basis is negative and occasionally large. We use the Treasury basis as a measure of the foreign convenience yield. Consistent with the theory, an increase in the convenience yield that foreign investors impute to U.S. Treasurys coincides with an immediate appreciation of the dollar, but predicts future depreciation of the dollar. The Treasury basis variation accounts for up to 25% of the quarterly variation in the dollar between 1988 and 2017. |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3621&r=ifn |
| By: | Andonov, Aleksandar (Erasmus University Rotterdam); Rauh, Joshua D. (Stanford University) |
| Abstract: | Institutional investors rely on past performance in setting future return expectations, and these extrapolative expectations affect their target asset allocations. Drawing on newly-required disclosures for U.S. public pension funds, a group that manages approximately $4 trillion of assets, we find that cross-sectional variation in past returns contributes substantial power for explaining real portfolio expected returns and expected risk premia in individual asset classes. Pension fund past performance affects real return assumptions across all risky asset classes, including in public equity where the relative performance of institutional investors is not persistent. In private equity, the extrapolation of past performance is driven by stale investments. State and local governments that are more fiscally stressed by higher unfunded pension liabilities assume higher portfolio returns, both through higher inflation assumptions and higher real returns, but this factor does not attenuate the extrapolative effects. Expected risk premia in public equity, private equity, and real assets are all correlated with funds' target asset allocation. Realized past returns affect the target asset allocation through an extrapolation channel. |
| JEL: | D83 D84 G11 G23 G28 H75 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3659&r=ifn |