Risk Appetite and Exchange Rates

45 Pages Posted: 5 Feb 2009 Last revised: 29 Mar 2018

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Erkko Etula


Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: May 2010


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.

Keywords: asset pricing, financial intermediaries, exchange rates

JEL Classification: F30, F31, G12, G24

Suggested Citation

Adrian, Tobias and Etula, Erkko and Shin, Hyun Song, Risk Appetite and Exchange Rates (May 2010). FRB of New York Staff Report No. 361. Available at SSRN: https://ssrn.com/abstract=1338121 or http://dx.doi.org/10.2139/ssrn.1338121

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://www.tobiasadrian.com

Erkko Etula

Independent ( email )

No Address Available

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

Register to save articles to
your library


Paper statistics

Abstract Views
PlumX Metrics