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Risk Appetite and Exchange RatesTobias AdrianFederal Reserve Bank of New York Erkko Etulaaffiliation not provided to SSRN Hyun Song ShinPrinceton University - Department of Economics May 2010 FRB of New York Staff Report No. 361 Abstract: We present evidence that the funding liquidity aggregates of U.S. financial intermediaries forecast U.S. dollar exchange rate growth—at weekly, monthly, and quarterly horizons, both in-sample and out-of-sample, and against a large set of foreign currencies. We provide a theoretical foundation for a funding liquidity channel in a simple asset pricing model where the effective risk aversion of dollar-funded intermediaries fluctuates with the tightness of their risk constraints. We estimate prices of risk using a cross-sectional asset pricing approach and show that U.S. dollar funding liquidity forecasts exchange rates because of its association with time-varying risk premia. Our empirical evidence shows that this channel is separate from the more familiar “carry trade” channel.
Number of Pages in PDF File: 45 Keywords: asset pricing, financial intermediaries, exchange rates JEL Classification: F30, F31, G12, G24 working papers seriesDate posted: February 5, 2009 ; Last revised: November 10, 2010Suggested CitationContact Information
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