nep-ifn New Economics Papers
on International Finance
Issue of 2021‒01‒11
two papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. The Global Factor Structure of Exchange Rates By Sofonias A. Korsaye; Fabio Trojani; Andrea Vedolin
  2. Exchange Rate Fluctuations and Firm Leverage By Ilhyock Shim; Sebnem Kalemli-Ozcan; Xiaoxi Liu

  1. By: Sofonias A. Korsaye (University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute); Fabio Trojani (Swiss Finance Institute; University of Geneva); Andrea Vedolin (Boston University - Department of Finance & Economics)
    Abstract: We provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international assets, such as stocks, bonds, and currencies, in the presence of frictions. We theoretically establish a two-factor representation for the cross-section of international SDFs, consisting of one global and one local factor, which is independent of the currency denomination. We show that our two-factor specification prices a large cross-section of international asset returns, not just in- but also out-of-sample with R2s of up to 80%.
    Keywords: International asset pricing, stochastic discount factor, factor models, financial frictions, market segmentation, incomplete markets, capital flows, regularization, lasso
    JEL: F31 G15
    Date: 2020–10
  2. By: Ilhyock Shim; Sebnem Kalemli-Ozcan; Xiaoxi Liu
    Abstract: We quantify the effect of exchange rate fluctuations on firm leverage. When home currency appreciates, firms who hold foreign currency debt and local currency assets observe higher net worth as appreciation lowers the value of their foreign currency debt. These firms can borrow more as a result and increase their leverage. When home currency depreciates, the reverse happens as firms have to de-lever with a negative shock to their balance sheets. Using firm-level data for leverage from 10 emerging market economies during the period from 2002 to 2015, we show that firms operating in countries whose non-financial sectors hold more of the debt in foreign currency, increase (decrease) their leverage relatively more after home currency appreciations (depreciations). Combining the leverage data with firm-level FX debt data for 4 emerging market countries, we further show that our results hold at the most granular level. Our quantitative results are asymmetric: the effects of depre-ciations, that are generally associated with sudden stops, are quantitatively larger than those of appreciations, which take place at a slower pace over time during capital inflow episodes. As our exercise compares depreciations and appreciations of similar size, these results are suggestive of financial frictions being more binding during depreciations than a possible relaxation of such frictions during appreciations.
    Date: 2020–12–11

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