nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒05‒30
seven papers chosen by
Martin Berka
Massey University

  1. The Dominant Currency Financing Channel of External Adjustment By Camila Casas; Sergii Meleshchuk; Yannick Timmer
  2. Lockdown Spillovers By Hongyi Chen; Peter Tillmann
  3. European Exchange Rate Adjustments in Response to COVID-19, Containment Measures and Stabilization Policies By Jens Klose
  4. Sovereign Debt Repatriation During Crises By Mr. Serkan Arslanalp; Laura Sunder-Plassmann
  5. Sovereign Defaults and Debt Sustainability: The Debt Recovery Channel By Ibrahima Diarra; Michel Guillard; Hubert Kempf
  6. FX option volume By Czech, Robert; Della Corte, Pasquale; Huang, Shiyang; Wang, Tianyu
  7. Sovereign Cocos By Mr. Leonardo Martinez; Juan Carlos Hatchondo; Mr. Francisco Roch; Kursat Onder

  1. By: Camila Casas; Sergii Meleshchuk; Yannick Timmer
    Abstract: We provide evidence of a new channel of how exchange rates affect trade. Using a novel identification strategy that exploits firms' foreign currency debt maturity structure in Colombia around a large depreciation, we show that firms experiencing a stronger debt revaluation of dominant currency debt due to a home currency depreciation compress imports relatively more while exports are unaffected. Dominant currency financing does not lead to an import compression for firms that export, hold foreign currency assets, or are active in the foreign exchange derivatives markets, as they are all hedged against a revaluation of their debt. These findings can be rationalized through the prism of a model with costly state verification and foreign currency borrowing. Dominant currency pricing mutes the effects of dominant currency financing on imports relative to producer currency pricing.
    Keywords: Imports; Exports; Foreign Currency Exposure; Capital Structure; Exchange Rates; Debt Revaluation; Hedging
    JEL: F31 F32 F41 G15 G21 G32
    Date: 2022–05–12
  2. By: Hongyi Chen (Hong Kong Institute for Monetary and Financial Research); Peter Tillmann (University of Giessen)
    Abstract: Lockdowns imposed to fight the Covid-19 pandemic have cross-border effects. In this paper, we estimate the empirical magnitude of lockdown spillovers in a set of panel local projections. We use daily indicators of economic activity such as stock returns, effective exchange rates, NO2 emissions, mobility and maritime container trade. Lockdown shocks originating in the most important trading partners have a strong and significant adverse effect on economic activity in the home economy. For stock prices and exports, the spillovers can even be larger than the effect of domestic lockdown shocks. The results are robust with respect to alternative country weights used to construct foreign shocks, i.e. weights based on foreign direct investment or the connectedness through value chains. We find that lockdown spillovers have been particularly strong during the first wave of the pandemic. Countries with a higher export share are particularly exposed to lockdown spillovers.
    Keywords: panel local projections, lockdown shocks, spillovers, Covid-19, pandemic
    JEL: E32 F14 F20 F36 F42 F44
    Date: 2022
  3. By: Jens Klose (THM Business School Giessen)
    Abstract: This paper estimates the effects of nine exchange rates for european countries vis-a-vis the Euro in the COVID pandemic. Using data on COVID cases, three containment and two stabilization measures relative to the euro area counterparts, it is shown that a more severe spread of the virus leads to a depreciation of the domestic currency. The same holds with respect to stricter movement restrictions, health care measures and more supportive monetary policies. More expansionary fiscal policies by the domestic country on the other hand lead to an appreciation of the currency. Two extensions show that the results differ with respect to whether the country is a scandinavian or eastern european country and whether the euro area countries or the other european countries introduce the measures.
    Keywords: Exchange rates, COVID-19, Europe, stabilization policies, containment measures, panel VAR
    JEL: E44 E52 E62
    Date: 2022
  4. By: Mr. Serkan Arslanalp; Laura Sunder-Plassmann
    Abstract: We use a new, comprehensive data set on the sovereign debt investor base to document three novel empirical facts: (i) sovereign debt is repatriated - that is, shifted from external private to domestic investors - prior to sovereign defaults; (ii) not all crises are equal: evidence for repatriation during banking and currency crises is more limited; and (iii) the nature of defaults matters: external investors do not leave during preemptive debt restructurings. We further show that repatriation appears to be prevalent when defaults happen in large markets with low capital controls. The data set we use is uniquely suited to analyzing investor base dynamics during rare crises due to its large cross-section and time series, covering 180 countries from 1989 to 2020.
    Keywords: Sovereign debt, External debt, Capital flows, Sovereign default, Financial crisis, Banking crisis, Currency crisis
    Date: 2022–04–29
  5. By: Ibrahima Diarra; Michel Guillard; Hubert Kempf
    Abstract: This paper focuses on the debt recovery channel linking the dynamics of public debt to partial sovereign defaults. We build a simple model which incorporates sovereign default and a debt recovery rule. It depends on a parameter that allows for partial debt recovery. We show that the maximum debt-to-GDP ratio that a country can sustain without defaulting is increasing, nonlinear, and sensitive to the debt-recovery parameter. A higher debt recovery parameter increases the fiscal space but worsens the financial position of a borrowing country after a default episode. We show the empirical relevance of this channel for estimating country-specific fiscal spaces.
    Date: 2022
  6. By: Czech, Robert (Bank of England); Della Corte, Pasquale (Imperial College London and Centre for Economic Policy Research (CEPR)); Huang, Shiyang (University of Hong Kong); Wang, Tianyu (Bank of England)
    Abstract: We study the information content of foreign exchange (FX) option volume using a unique dataset on over-the-counter FX options with disclosed counterparty identities and contract characteristics. Our study shows that FX option volume can predict future exchange rate returns, especially when the demand for the US dollar is high. In support of information-based arguments, we also document that the exchange rate predictability is stronger around macro-announcement days or when using options with higher embedded leverage. Finally, we show that hedge funds and real money investors have superior skills in predicting future exchange rates compared to other investor types.
    Keywords: Currency return; foreign exchange option; Informed trading; dollar demand
    JEL: F31 G12 G14 G15
    Date: 2022–03–04
  7. By: Mr. Leonardo Martinez; Juan Carlos Hatchondo; Mr. Francisco Roch; Kursat Onder
    Abstract: We study a model of equilibrium sovereign default in which the government issues cocos (contingent convertible bonds) that stipulate a suspension of debt payments when the government faces liquidity shocks in the form of an increase of the bondholders' risk aversion. We find that in spite of reducing the frequency of defaults triggered by liquidity shocks, introducing cocos increases the overall default frequency. By mitigating concerns about liquidity, cocos make indebtedness and default risk more attractive for the government. In contrast, cocos that stipulate debt forgiveness when the government faces the shock, achieve larger welfare gains by reducing default risk.
    Keywords: Sovereign Cocos, default risk, maturity extensions, reprofiling, haircuts.; liquidity shock; default frequency; government issues coco; risk-premium shock; debt payment; Contingent convertible capital; Debt default; Debt relief; Consumption; Return on investment; Global
    Date: 2022–04–29

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