nep-ifn New Economics Papers
on International Finance
Issue of 2021‒05‒17
five papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India By Acharya, Viral V.; Vij, Siddharth
  2. Global Portfolio Rebalancing and Exchange Rates By Camanho, Nelson; Hau, Harald; Rey, Hélène
  3. Pricing Currency Risks By Chernov, Mikhail; Dahlquist, Magnus; Lochstoer, Lars
  4. CIP Deviations, the Dollar, and Frictions in International Capital Markets By Wenxin Du; Jesse Schreger
  5. How ETFs amplify the global financial cycle in emerging markets By Nathan Converse; Eduardo Levy Yeyati; Tomas Williams

  1. By: Acharya, Viral V.; Vij, Siddharth
    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.
    Keywords: emerging markets; foreign currency debt; Foreign exchange risk; taper tantrum
    JEL: F31 F34 G15 G30
    Date: 2020–11
  2. By: Camanho, Nelson; Hau, Harald; Rey, Hélène
    Abstract: We examine international equity allocations at the fund level and show how excess foreign returns influence portfolio rebalancing, capital flows and currencies. Our equilibrium model of incomplete FX risk trading where exchange rate risk partially segments international equity markets is consistent with the observed dynamics of equity returns, exchange rates, and fund-level capital flows. We document that rebalancing is more intense under higher FX volatility and Â?find heterogeneous rebalancing behavior across different fund characteristics. A granular instrumental variable (GIV) approach identiÂ?es a currency supply elasticity suggesting that an equity outflow shock of US$7.1 billion depreciates the dollar by 1 percent.
    Date: 2020–12
  3. By: Chernov, Mikhail; Dahlquist, Magnus; Lochstoer, Lars
    Abstract: The currency market features a relatively small cross-section and conditional expected returns can be characterized by only a few signals â?? interest differentials, trend and mean-reversion. We exploit these properties to construct a conditional projection of the stochastic discount factor onto excess returns of individual currencies. Our approach is implementable in real time and prices all currencies and prominent strategies conditionally as well as unconditionally. We document that the fraction of unpriced risk in these assets is at least 85%. Extant explanations of carry strategies based on intermediary capital or global volatility are related to these unpriced components, while consumption growth is related to the priced component of returns.
    Keywords: currency risk premiums; factor models; Stochastic discount factor
    JEL: F31 G12 G15
    Date: 2020–12
  4. By: Wenxin Du; Jesse Schreger
    Abstract: The covered interest rate parity (CIP) condition is a fundamental arbitrage relationship in international finance. In this chapter, we review its breakdown during the Global Financial Crisis and its continued failure in the subsequent decade. We review how to measure CIP deviations, discuss the drivers of CIP deviations, and the implications of CIP deviations for global financial markets.
    JEL: E0 F0 G0
    Date: 2021–05
  5. By: Nathan Converse (Federal Reserve Board); Eduardo Levy Yeyati (Universidad Torcuato Di Tella/The Brookings Institution); Tomas Williams (George Washington University)
    Abstract: Since the early 2000s exchange-traded funds (ETFs) have grown to become an important in- vestment vehicle worldwide. In this paper, we study how their growth affects the sensitivity of international capital flows to the global financial cycle. We combine comprehensive fund- level data on investor flows with a novel identification strategy that controls for unobservable time-varying economic conditions at the investment destination. For dedicated emerging market funds, we find that the sensitivity of investor flows to global financial conditions for equity (bond) ETFs is 2.5 (2.25) times higher than for equity (bond) mutual funds. In turn, we show that in countries where ETFs hold a larger share of financial assets, total cross-border equity flows and prices are significantly more sensitive to global financial conditions. We conclude that the growing role of ETFs as a channel for international capital flows amplifies the global financial cycle in emerging markets.
    Keywords: exchange-traded funds mutual funds global financial cycle global risk push and pull factors capital flows emerging markets
    JEL: F32 G11 G15 G23
    Date: 2021–04

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