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on International Finance |
| By: | Luis M. Viceira; Sally Shen |
| Abstract: | This paper examines optimal currency demands for global equity and bond investors in a large cross-section of developed and emerging markets over the 1975-2023 period. It extends the framework of Campbell et al. (2010) by incorporating both optimal portfolio-risk minimizing currency exposures, accounting for empirically measured hedging costs arising from deviations of Covered Interest Parity (CIP), and optimal expected-return-driven currency demands based on non-zero expected excess currency returns arising from empirically measured deviations of Uncovered Interest Parity (UIP). The analysis shows that the main conclusions of their portfolio risk-minimizing framework hold for this larger and longer panel of countries and that they are robust to deviations from CIP. Specifically, it is optimal for portfolio risk-minimizing equity investors to hold exposures to the U.S. dollar and the euro while avoiding exposure to all other currencies, whereas bond investors should hedge all currency exposures. In contrast, observed deviations from UIP are sufficiently large and persistent among currencies with high average relative interest currencies, especially Emerging Markets currencies, to generate expected return-driven currency demands that offset, and in some cases reverse, portfolio-risk minimizing demands, even for investors with low risk tolerance. The average excess returns on those currencies are large enough to compensate investors for their substantial return volatility and strong positive covariance with equity returns. |
| JEL: | F0 F21 F23 F3 F30 F31 F37 G0 G1 G11 G15 |
| Date: | 2026–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35498 |
| By: | Tarek Alexander Hassan; Thomas Mertens; Jingye Wang |
| Abstract: | We show that quantitative asset pricing models, built to address the equity premium and risk-free rate puzzles, systematically fail when applied to open economies: they cannot generate the large and persistent interest rate differentials we observe between risky and safe currencies. This failure stems from the key mechanism that produces their success in matching both closed-economy puzzles: In these models, the mean of the stochastic discount factor offsets its variance nearly one-for-one, which immobilizes interest rates --- so that differences in expected currency returns across countries must arise almost exclusively from predictable changes in exchange rates, at odds with the data. We prove this result in a broad class of models that allows for market incompleteness and exchange rate disconnect, requiring only that each country's risk-free asset is priced by investors who demand compensation for risk in line with observed risk premia. We argue this tension between canonical asset pricing and international macroeconomic models is a key reason researchers have struggled to reconcile the observed behavior of exchange rates, interest rates, and capital flows across countries. |
| JEL: | E43 F31 F4 G12 G15 |
| Date: | 2026–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35572 |
| By: | Anusha Chari; Gian Maria Milesi Ferretti |
| Abstract: | This paper analyzes foreign demand for U.S. assets, with particular emphasis on U.S. Treasury securities. It documents compositional shifts in U.S. bilateral external positions across geographic regions and asset classes, providing estimates of creditor positions closer to a nationality-based concept. While rising U.S. equity prices explain a sizable share of the deterioration in the net external position, foreign purchases of U.S. Treasury securities have been the largest source of U.S. current account financing. The share of these securities held by foreign official investors has declined sharply during the past decade, while the share held by foreign private investors (especially through financial centers) has risen. The decline in foreign official holdings is well explained by lower reserve accumulation, increased Federal Reserve holdings, and dollar appreciation against other reserve currencies. The evidence is consistent with central banks rebalancing their portfolios to avoid large swings in currency shares. Geoeconomic fragmentation is negatively correlated with official demand for U.S. Treasuries, while foreign private demand remains sensitive to safe-haven dynamics. Overall, the paper assesses how these structural shifts affect portfolio preferences for U.S. assets and their potential implications for the U.S. external position amid heightened geopolitical and fiscal uncertainty. |
| JEL: | F21 F32 F34 G15 H60 H63 |
| Date: | 2026–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35555 |
| By: | Valentin Burban; Pavel Diev; Gilles Dufrénot; Nelson Mongeaud |
| Abstract: | This paper proposes a new empirical taxonomy of safe assets based on their safe-haven behavior during periods of global risk aversion. Our multi-criteria framework captures the persistent performance of bond securities, currencies, and alternative assets during episodes of acute risk-off sentiment, allowing us to construct a cross-asset ranking of safe-haven behavior by asset characteristics: global safe assets, credit-sensitive assets, and emerging assets. We find that sovereign bonds issued by G10 economies, including U.S. Treasuries, consistently exhibit the strongest safe-haven behavior. A limited set of corporate bond markets displays partial safe-asset characteristics, while gold is the only alternative asset that consistently scores highly across our safe-haven criteria, particularly during periods of geopolitical risk. We further show that U.S. Treasuries have exhibited weaker safe-haven properties since the pandemic, although this reflects a broader reconfiguration of global safe-asset hedging properties rather than a uniquely U.S. decline. We find that weaker safe-haven properties are associated with higher inflation, debt levels and scarcity of available assets. |
| Keywords: | Safe Assets, Safe-Haven, U.S. Treasuries, Asset Pricing, Risk Aversion. |
| JEL: | F31 E44 G01 G12 G15 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:bfr:banfra:1049 |
| By: | Thomas Drechsel (University of Maryland, NBER, CEPR); Michael McLeay (Bank of England); Silvana Tenreyro (London School of Economics); Enrico D Turri (London School of Economics) |
| Abstract: | We show that the optimal monetary policy and exchange rate framework depend critically on the economy’s commodity exposure. We develop a flexible but tractable model economy with commodity exports and imports, in which international financial conditions may vary with the commodity cycle, and we compute the welfare-optimal policy in the presence of price and wage rigidities. Stabilising domestic prices is welfare-optimal for commodity exporters, in line with standard open-economy policy prescriptions. But for economies that use commodities as inputs in production, optimal policy largely ‘looks through’ the direct and indirect effects of commodity shocks on domestic prices; this contrasts with some earlier findings and policy practice (which only ‘looks through’ the direct effect). In emerging and developing economies, where financial conditions are more tied to the commodity cycle, trade-offs are starker and implementing the optimal policy may be challenging, since it requires enough credibility to keep inflation expectations anchored amidst greater volatility in some nominal variables. |
| Keywords: | Monetary policy;exchange rates;inflation targeting;commodity prices;small open economy |
| JEL: | E31 E52 E58 F41 Q02 Q30 |
| Date: | 2026–06–05 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023308 |
| By: | Deborah Gefang; Stephen G. Hall; George S. Tavlas |
| Abstract: | We examine how macroeconomic and geopolitical developments in the United States, the euro area, and China affect the currency composition of central banks' foreign exchange reserves. Using an unbalanced panel of reserve shares for 53 countries over 1999-2023, we estimate a constrained system of equations that explicitly imposes the adding-up restriction on reserve shares. The results indicate substantial persistence in reserve holdings and significant cross-currency dependence, supporting a system-wide dynamics of reserve composition. In the country fixed-effects specification (1) issuer economic size, (2) uncertainty, (3) sanctions, (4) trade linkages, and (5) issuer credibility are significantly associated with reserve allocation across currencies. With the inclusion of year fixed effects, the persistence and cross-currency dependence remain, while trade linkages and sanctions emerge as the most important determinants of reserve composition. The results highlight the importance of accounting for the compositional nature and interdependence of reserve shares when examining the determinants of global reserve holdings. |
| Date: | 2026–08 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2608.24468 |
| By: | Ana Aguilar (Consejo Mexicano de Negocios (CMN)); Rafael Guerra (Bank for International Settlements (BIS)); Carola Müller (Banco de España); Alexandre Tombini (Bank for International Settlements (BIS)) |
| Abstract: | This paper investigates the impact of domestic economic policy uncertainty (EPU) on macroeconomic and financial variables in emerging market economies, focusing on Latin America. Using panel data for Brazil, Chile, Colombia, Mexico and Peru from 2005 to early 2025, we find that domestic EPU shocks cause significant macroeconomic disruptions, leading to a contraction in output and a rise in inflation, akin to a supply shock. These effects are transmitted through a financial channel in the short term, via higher risk premia, increased equity market volatility and exchange rate depreciations, and through a real channel in the medium term, via declines in growth expectations and consumer and business confidence. Our analysis further reveals that EPU shocks aggravate episodes of weak economic conditions and tighter financial conditions, while stronger economies are better able to absorb such shocks. |
| Keywords: | macroeconomy, uncertainty, economic policy uncertainty, Latin America |
| JEL: | C33 D80 E23 E31 |
| Date: | 2026–09 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2625 |
| By: | Michael D. Bordo; Cécile Bastidon |
| Abstract: | We propose stress tests based on an original International Monetary System (IMS) model with regime switchings. The model is calibrated for nine reference currencies from the beginning of the Classical Gold Standard to the present. Regime switchings in currency dominance are related to combinations of conditions on a multidimensional environment variable that includes five classes of shocks: technology; development; monetary, financial and fiscal institutions; democracy and conflicts; and the regulatory environment. We provide an original database of events for these five classes of shocks, which is used for calibration. The calibration highlights the important role of the democracy and conflicts component in regime switchings. The calibrated model is then used to perform stress tests on the current prospects of currency dominance for a broad set of scenarios. A salient result from the scenarios we tested is that the dominance of the US dollar is at most marginally affected. No other currency emerges as a major player, suggesting strong inertia in the system’s current centripetal dynamics. |
| JEL: | C3 C82 E42 F33 G15 N2 |
| Date: | 2026–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35647 |
| By: | Francisco Roldan; César Sosa-Padilla |
| Abstract: | Motivated by the emergence of new official creditors outside the Paris Club framework, we study the interaction between senior official lending and market debt. We develop a quantitative sovereign default model featuring a large senior lender with whom borrowing terms are negotiated. Obtaining more net financing from the market strengthens the government’s bargaining position and improves bilateral terms. This endogenous cross-elasticity erodes the discipline of spreads and amplifies debt dilution, leading to welfare losses even as bilateral borrowing helps avert some defaults ex-post. With pre-specified rules, rewarding market issuance can be enough to generate such losses, and an optimal rule instead raises bilateral rates with net market financing. The direction of the cross-elasticity can thus guide in practice the assessment of new forms of bilateral sovereign debt. |
| JEL: | F34 F41 G15 |
| Date: | 2026–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35590 |
| By: | Dennis Reinhardt (Bank of England); Julian Reynolds (Bank of England); Rhiannon Sowerbutts (Bank of England) |
| Abstract: | How does geopolitical risk affect cross-border bank lending? To examine this question, we exploit a rich cross-border bank lending data set from the UK which records banks' large exposures to individual firms and match this with a firm-level measure of geopolitical risk, derived from firms' earnings call reports. Combining granular firm-level data points with tight fixed effect specifications, we find that a one standard deviation increase in geopolitical risk causes cross-border bank lending to decline by around 4% after one year. This effect is not uniform: lending to financial sector firms declines most, while energy and defence sectors show no significant impact; also better-capitalised banks are less sensitive to borrower risk. Effects vary with geopolitical alignment between bank and firm nationalities and are more significant for sanctions-related risk. Finally, local projections show that geopolitical risk transmits to cross-border lending via macroeconomic aggregates and asset prices, with transmission influenced by credit growth dynamics and sanctions as the primary risk driver. |
| Keywords: | Geopolitical risk;cross-border bank lending;international banking;financial fragmentation;economic sanctions. |
| JEL: | F3 F34 F51 G21 |
| Date: | 2025–12–19 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023286 |