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on International Finance |
| By: | Kristy Jansen; Hyun Song Shin; Goetz von Peter |
| Abstract: | How do exchange rates affect the asset allocation of bond portfolio investors? Using detailed security-level holdings, we find that euro area-based investors systematically shed sovereign bonds as the dollar strengthens, confirming the role of the dollar as a global risk factor even for euro-based investors. More distinctively, they also shed local currency bonds when the euro strengthens, due to currency mismatches on their own balance sheets. There is no such effect for foreign currency bonds of the same sovereign issuers. These findings are consistent with a Value-at-Risk portfolio choice model that brings out separate roles for local, foreign and reference currencies. |
| Keywords: | Currency mismatch, balance sheet effects, emerging markets, exchange rates, institutional investors, sovereign bonds |
| JEL: | F31 G11 G15 G23 |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:bis:biswps:1210 |
| By: | Chetan Ghate (Indian Statistical Institute – Delhi); Kenneth Kletzer (University of California); Mahima Yadav (Indian Statistical Institute – Delhi) |
| Abstract: | India accumulated a sizable stock of foreign reserves over the past two decades, in common with many other emerging economies. Its current reserves comfortably surpass conventional thresholds for adequacy used by the International Monetary Fund and others. An assessment of whether the stock of reserves is appropriate should depend on an evaluation of the benefits and costs of reserves looking forward. Reserves provide self-insurance against sudden financial outflows by non-resident investors or resident savers and liquidity for managing exchange rates. While India’s reserves appear to be ample for meeting both these needs, additional reserves can reduce vulnerability to capital flow reversals that can be crisis inducing. The empirical analysis of India’s external portfolio capital flows finds that reserves lower outflows in the event of global financial distress at the margin. Reserve holdings reduce the volatility of portfolio debt flows in response to relative policy interest rate shocks. The results indicate that additions to reserves reduce the economy’s exposure to global financial risk. The precautionary benefits of reserves could well increase as India becomes further integrated to international financial markets. Estimates of the costs of holding reserves give evidence that increases in the reserves to output ratio reduce the risk premium on reserves, so that the sovereign interest rate spread overestimates the marginal cost of reserves. |
| Keywords: | Foreign exchange reserves, foreign portfolio flows, precautionary reserves, global financial shocks. |
| JEL: | F31 F32 E52 |
| Date: | 2024–05–24 |
| URL: | https://d.repec.org/n?u=RePEc:nca:ncaerw:168 |
| By: | Mikhail Chernov; Magnus Dahlquist; Lars A. Lochstoer |
| Abstract: | We show that a small set of emerging markets with floating exchange rates expand the investment frontier substantially relative to G10 currencies. The frontier is characterized by an out-of-sample mean-variance efficient portfolio that prices G10- and emerging markets-based trading strategies unconditionally as well as conditionally. Our approach reveals that returns to prominent trading strategies are largely driven by factors that do not command a risk premium. After real-time hedging of such unpriced risks, the Sharpe ratios of these strategies increase substantially, providing new benchmarks for currency pricing models. For instance, the Sharpe ratio of the carry strategy increases from 0.71 to 1.29. The unpriced risks are related to geographically-based currency factors, while the priced risk that drives currency risk premiums is related to aggregate consumption exposure. |
| JEL: | F31 G12 G15 |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32900 |
| By: | António Afonso; José Alves; João Jalles; Sofia Monteiro |
| Abstract: | This study examines the effects of geopolitical risk and global uncertainty on energy prices, conditioned by different exchange rate regimes, for 185 economies over the period 1980-2023. The central question is how uncertainty impacts energy prices and whether exchange rate flexibility mediates these effects. Using panel data techniques, including OLS and Panel VAR, we assess both demand and supply-side channels, exploring country-specific differences. Our key findings indicate that uncertainty shocks significantly raise energy prices, particularly in countries with flexible exchange rates, where currency depreciation amplifies global price fluctuations. Asymmetric results are found regarding emerging markets, with flexible exchange rates, which tend to have lower energy prices, while oil-exporting countries and OPEC members experience distinct pricing dynamics. These results underscore the importance of exchange rate policy choices in shaping energy market responses to global shocks. Policymakers may need to adopt complementary measures to manage the volatility arising from global uncertainty. |
| Keywords: | Geopolitical Risk; World Uncertainty Index; Global Energy Markets; Exchange Rate Regimes; Asymmetric Effects. |
| JEL: | C23 E44 G32 H63 |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:ise:remwps:wp03442024 |
| By: | Jakree Koosakul; Ms. Longmei Zhang; Maryam Zia |
| Abstract: | After decades of increasing global economic integration, the world is facing a growing risk of geoeconomic fragmentation, with potentially far-reaching implications for the global economy and the international monetary system. Against this background, this paper studies how geopolitical proximity, along with other economic factors, affects the usage of five SDR currencies in cross-border transactions. Since World War II, the global currency landscape has remained relatively stable, with the U.S. dollar serving as the dominant currency. Using country-level SWIFT transaction data, our analysis confirms the importance of inertia, trade and financial linkages in shaping the currency landscape, consistent with existing studies. On geopolitical proximity, we find that closer proximity can boost the use of the euro and renminbi, notably among emerging market and developing economies, although the impact is rather muted in the full sample. The effect on RMB usage in the full sample is more pronounced during periods of heightened trade policy uncertainty. These findings suggest that in a more geoeconomically fragmented world, alternative currencies could play a greater role. |
| Date: | 2024–09–06 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/189 |