nep-ifn New Economics Papers
on International Finance
Issue of 2022‒07‒18
six papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. The Rest of the World’s Dollar-Weighted Return on U.S. Treasurys By Zhengyang Jiang; Arvind Krishnamurthy; Hanno Lustig
  2. A Structural Dynamic Factor Model for Daily Global Stock Market Returns By Linton, O. B.; Tang, H.; Wu, J.;
  3. The Currency Channel of the Global Bank Leverage Cycle By Justine Pedrono
  4. Who Holds Sovereign Debt and Why It Matters By Xiang Fang; Bryan Hardy; Karen K. Lewis
  5. Steering a Ship in Illiquid Waters: Active Management of Passive Funds By Naz Koont; Yiming Ma; Lubos Pastor; Yao Zeng
  6. On Wars, Sanctions and Sovereign Default By Javier Bianchi; Cesar Sosa-Padilla

  1. By: Zhengyang Jiang; Arvind Krishnamurthy; Hanno Lustig
    Abstract: Since 1980, foreign investors have timed their purchases and sales of U.S. Treasurys to yield particularly low returns. Their annual dollar-weighted returns, measured by IRRs, are around 3% lower than a buy-and-hold strategy over the same horizon. In comparison, the IRRs achieved by domestic investors are at least 1% higher, while the IRRs achieved by the Federal Reserve are similarly low. Our results are consistent with theories where foreign investors are price-inelastic buyers of safe dollar assets, which provide them with convenience services.
    JEL: F32 G12
    Date: 2022–05
  2. By: Linton, O. B.; Tang, H.; Wu, J.;
    Abstract: Most stock markets are open for 6-8 hours per trading day. The Asian, European and American stock markets are separated in time by time-zone differences. We propose a statistical dynamic factor model for a large number of daily returns across multiple time zones. Our model has a common global factor as well as continental factors. Under a mild fixed-signs assumption, our model is identified and has a structural interpretation. We propose several estimators of the model: the maximum likelihood estimator-one day (MLE-one day), the quasi-maximum likelihood estimator (QMLE), an improved estimator from QMLE (QMLE-md), the QMLEres (similar to MLE-one day), and a Bayesian estimator (Gibbs sampling). We establish consistency, the rates of convergence and the asymptotic distributions of the QMLE and the QMLE-md. We next provide a heuristic procedure for conducting inference for the MLE-one day and the QMLE-res. Monte Carlo simulations reveal that the MLE-one day, the QMLE-res and the QMLE-md work well. We then apply our model to two real data sets: (1) equity portfolio returns from Japan, Europe and the US; (2) MSCI equity indices of 41 developed and emerging markets. Some new insights about linkages among different markets are drawn.
    Keywords: Daily Global Stock Market Returns, Expectation Maximization Algorithm, Minimum Distance, Quasi Maximum Likelihood, Structural Dynamic Factor Model, Time-Zone Differences
    JEL: C55 C58 G15
    Date: 2022–06–15
  3. By: Justine Pedrono
    Abstract: The amplitude of leverage procyclicality is heterogeneous across banks and across countries. This paper introduces international diversification of bank balance sheet as a factor of this observed heterogeneity, with a special emphasis on currency diversification. Based on a new theoretical framework, it shows that the impact of international diversification on leverage procyclicality depends on the relative performance of economies, the global business cycle and the exchange rate regime. By altering the distribution of global bank portfolio, international diversification adds a currency channel to the risk channel of the global leverage cycle. Using granular data on banks located in France, the paper shows that the pre-crisis international diversification of banks increased leverage procyclicality during the 2008-2009 crisis. Focusing on the currency channel, namely the valuation effect of currency diversification, results show that it had a negative effect on leverage procyclicality during this period, hence decreasing procyclicality. The currency channel contributed to offset part of the increased risk due to the crisis and the risk channel. These findings draw attention to the specific role of balance sheet currency diversification in financial stability risk.
    Keywords: Bank, Financial Cycles, Leverage, Internationalization, International Portfolio, Currency
    JEL: E32 F34 F36 F44 G15 G20
    Date: 2022
  4. By: Xiang Fang; Bryan Hardy; Karen K. Lewis
    Abstract: This paper studies the impact of investor composition on the sovereign debt market and the implied funding costs to borrowers. We construct an aggregate data set of sovereign debt holdings by foreign and domestic bank, non-bank private, and official investors for 95 countries over twenty years. We find that private non-bank investors absorb most of the increase in sovereign debt supply. We further find that foreign non-bank investor demand is most responsive to the yield for emerging market (EM) debt, while yield elasticity for all investors is much lower for advanced economy debt. We show that EM sovereigns are highly vulnerable to losing their foreign non-bank investors.
    JEL: F34 F41 G11 G15
    Date: 2022–05
  5. By: Naz Koont; Yiming Ma; Lubos Pastor; Yao Zeng
    Abstract: Exchange-traded funds (ETFs) are typically viewed as passive index trackers. In contrast, we show that corporate bond ETFs actively manage their portfolios, trading off index tracking against liquidity transformation. In our model, ETFs optimally choose creation and redemption baskets that include cash and only a subset of index assets, especially if those assets are illiquid. Our evidence supports the model's predictions. We find that ETFs dynamically adjust their baskets to correct portfolio imbalances while facilitating ETF arbitrage. Basket inclusion improves bond liquidity, except in periods of large imbalance between ETF creations and redemptions, such as the COVID-19 crisis of 2020.
    JEL: G12 G23
    Date: 2022–05
  6. By: Javier Bianchi (Federal Reserve Bank of Minneapolis); Cesar Sosa-Padilla (University of Notre Dame)
    Abstract: This paper explores the role of restrictions on the use of international reserves as economic sanctions. We develop a simple model of the strategic game between a sanctioning (creditor) country and a sanctioned (debtor) country. We show how the sanctioning country should impose restrictions optimally, internalizing the geopolitical benefits and the financial costs of a potential default from the sanctioned country.
    Date: 2022–06

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