nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒06‒08
five papers chosen by
Martin Berka
University of Auckland

  1. Shadow banking and the design of macroprudential policy in a monetary union By Philipp Kirchner; Benjamin Schwanebeck
  2. Foreign exchange order fl ow as a risk factor By Craig Burnside; Mario Cerrato; Zhekai Zhang
  3. Currency Swap Agreements and Financial Crises in Small Open Economies By Akihiko Ikeda
  4. Twin default crises By Mendicino, Caterina; Nikolov, Kalin; Suarez, Javier; Supera, Dominik; Ramirez, Juan-Rubio
  5. A Joint Foreign Currency Risk Management Approach for Sovereign Assets and Liabilities By Cangoz, Mehmet Coskun; Sulla, Olga; Wang, ChunLan; Dychala, Christopher Benjamin

  1. By: Philipp Kirchner (University of Kassel); Benjamin Schwanebeck (University of Hagen)
    Abstract: This paper studies the interaction of international shadow banking with monetary and macroprudential policy in a two-country currency union DSGE model. We fiÂ…nd evidence that cross-country fiÂ…nancial integration through the shadow banking system is a source of fiÂ…nancial contagion in response to idiosyncratic real and fiÂ…nancial shocks due to harmonization of fiÂ…nancial spheres. The resulting high degree of business cycle synchronization across countries, especially for Â…financial variables, makes union-wide policy tools more ffective. Nevertheless, optimal monetary policy at the union-level is too blunt an instrument to adequately stabilize business cycle downturns and needs to be accompanied by macroprudential regulation. Our welfare analysis reveals that the gains from the availability of country-speciÂ…c prudential tools vanish with the degree of fiÂ…nancial integration as union-wide macroprudential regulation is able to effectively reduce losses among the union members.
    Keywords: fiÂ…nancial frictions; shadow banking; currency union; Â…financial integration; macroprudential policy
    JEL: E32 E44 E58 F45
    Date: 2020
  2. By: Craig Burnside; Mario Cerrato; Zhekai Zhang
    Abstract: This paper proposes a set of novel pricing factors for currency returns that are mo- tivated by microstructure models. In so doing, we bring two strands of the exchange rate literature, namely market-microstructure and risk-based models, closer together. Our novel factors use order fl ow data to provide direct measures of buying and selling pressure related to carry trading and momentum strategies. We find that they appear to be good proxies for currency crash risk. Additionally, we show that the association between our order-fl ow factors and currency returns differs according to the customer segment of the foreign exchange market. In particular, it appears that financial cus- tomers are risk takers in the market, while non-financial customers serve as liquidity providers.
    Keywords: foreign, exchange, order fl ow, risk factor.
    JEL: E44 E51 F3 F4 G21
    Date: 2018–10
  3. By: Akihiko Ikeda (Department of Economics, Kyoto University of Advanced Science)
    Abstract: This paper studies the effects of an international currency swap agreement, or an exchange of hard currencies between countries, on the probability of financial crises. The analysis is based on a small open economy model with a financial constraint. A currency swap is described as a mutual provision of collateral goods between two countries. The results show that there are cases where a currency swap agreement can lower the probability of financial crises. Whether it can benefit both member countries depends on their difference in the size or probability of recessions, as well as the amount of collateral goods exchanged. Contracts of currency swaps should be designed in consideration of these factors.
    Keywords: Emerging economy, Financial crisis, Currency swap
    JEL: E32 F41 F44
    Date: 2020–05
  4. By: Mendicino, Caterina; Nikolov, Kalin; Suarez, Javier; Supera, Dominik; Ramirez, Juan-Rubio
    Abstract: We study the interaction between borrowers' and banks' solvency in a quantitative macroeconomic model with financial frictions in which bank assets are a portfolio of defaultable loans. We show that ex-ante imperfect diversification of bank lending generates bank asset returns with limited upside but significant downside risk. The asymmetric distribution of these returns and their implications for the evolution of bank net worth are important for capturing the frequency and severity of twin default crises – simultaneous rises in firm and bank defaults associated with sizeable negative effects on economic activity. As a result, our model implies higher optimal capital requirements than common specifications of bank asset returns, which neglect or underestimate the impact of borrower default on bank solvency. JEL Classification: G01, G28, E44
    Keywords: bank capital requirements, bank default, financial crises, firm default
    Date: 2020–05
  5. By: Cangoz, Mehmet Coskun; Sulla, Olga; Wang, ChunLan; Dychala, Christopher Benjamin
    Abstract: An asset and liability management framework for managing risks arising from sovereign foreign exchange obligations requires a joint analysis of (i) the external financial liabilities resulting from a country’s sovereign debt and (ii) the foreign exchange assets of its central bank. Governments often issue sizable amounts of debt denominated in foreign currencies, subjecting their fiscal positions to foreign exchange volatilities. Prudent management of a sovereign’s foreign exchange position under an asset and liability management framework enables governments to mitigate risks at the lowest possible cost, hence increasing resilience to external shocks. Based on the challenges associated with the implementation of an asset and liability management framework, this study recommends a practical approach that includes analysis of the foreign exchange positions of central bank reserves and central government debt portfolios and optimization of the net position. The proposed model is tested, using the foreign exchange reserve and external debt data of seven countries (Albania, Ghana, FYR Macedonia, South Africa, the Republic of Korea, Tunisia, and Uruguay). The paper employs quantitative methods to explore the impact of an overarching asset and liability management strategy and integrated approach on the efficient management of foreign exchange risk. It provides policy recommendations on ways to minimize the risk of foreign exchange mismatches and increase the return on foreign exchange reserves.
    Keywords: Exchange Rate Risk, Asset and Liability Management, Public Debt, Sovereign Balance Sheet, Macro Hedging, Portfolio Optimization, International Reserves, Strategic Asset Allocation
    JEL: E61 E63 F31 F34 F37 G11 G15 G17 G18 H63 H68
    Date: 2019–02–05

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