nep-ifn New Economics Papers
on International Finance
Issue of 2020‒12‒21
three papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India By Viral V. Acharya; Siddharth Vij
  2. Foreign Exchange Dealer Asset Pricing By Stefan Reitz; Dennis Umlandt
  3. Sudden Stops and Optimal Foreign Exchange Intervention By J. Scott Davis; Michael B. Devereux; Changhua Yu

  1. By: Viral V. Acharya; Siddharth Vij
    Abstract: We establish that macroprudential policies limiting capital flows can curb risks arising from corporate foreign currency borrowing in emerging markets. Using detailed firm-level data from India, we show that propensity to issue foreign currency debt for the same firm is higher when the difference in short-term interest rates between India and the US is higher, i.e., when the dollar ‘carry trade’ is more profitable; this behavior is driven by the period after the global financial crisis. The positive relationship between issuance and the ‘carry trade’ breaks down once regulators institute more stringent interest-rate caps on foreign currency borrowing. Riskier borrowers such as importers and those with higher interest costs cut issuance most. Firm equity exposure to foreign exchange risk rose after issuance in favorable funding conditions and emerged as a source of external sector vulnerability during the ‘taper tantrum’ of 2013. Macroprudential policy action limiting capital flows is able to nullify this effect, such as during the market stress due to the COVID-19 pandemic.
    JEL: F31 F34 G15 G30
    Date: 2020–11
  2. By: Stefan Reitz; Dennis Umlandt
    Abstract: We show that excess returns to the carry trade can be interpreted as compensationfor foreign exchange dealers’ capital risk. Given that the top market makers inforeign exchange are at the heart of the market’s information aggregation process wealso suggest that it is their marginal value of wealth which prices foreign currencies.Consistent with this hypothesis the empirical results show that shocks to the equitycapital ratios of the top three foreign exchange dealers have explanatory power forthe cross-sectional variation in expected currency market returns, while those of theaverage dealer provide no substantial additional information.
    Keywords: Carry Trades, FX Dealers, Currency Risk, Intermediary Asset Pricing
    JEL: F31 G12 G15
    Date: 2019
  3. By: J. Scott Davis; Michael B. Devereux; Changhua Yu
    Abstract: This paper shows that foreign exchange intervention can be used to avoid a sudden stop in capital flows in a small open emerging market economy. The model is based around the concept of an under-borrowing equilibrium defined by Schmitt-Grohe and Uribe (2020). With a low elasticity of substitution between traded and non-traded goods, real exchange rate depreciation may generate a precipitous drop in aggregate demand and a tightening of borrowing constraints, leading to an equilibrium with an inefficiently low level of borrowing. The central bank can preempt this deleveraging cycle through foreign exchange intervention. Intervention is effective due to frictions in private international financial intermediation. Reserve accumulation has ex ante benefits by reducing the risk of a sudden stop, while intervention has ex-post benefits by limiting inefficient deleveraging. But intervention itself faces constraints. When the central bank’s stock of reserves is low, even foreign exchange intervention cannot prevent a sudden stop.
    JEL: E30 E50 F40
    Date: 2020–11

This nep-ifn issue is ©2020 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.