The Crisis in the Foreign Exchange Market

40 Pages Posted: 22 Jul 2009

See all articles by Michael Melvin

Michael Melvin

University of California, San Diego (UCSD) - Rady School of Management; CESifo (Center for Economic Studies and Ifo Institute)

Mark P. Taylor

Barclays - Barclays Global Investors (London)

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Date Written: July 2009

Abstract

The financial crisis of 2007-2008 had major implications for the foreign exchange market. We review events and implications for exchange rates, volatility, returns to currency investing, and transaction costs. This “blow-by-blow” narrative is intended to be a resource for researchers seeking a comprehensive review of the “what, why and when” of the financial crisis in terms of foreign exchange market dynamics. An implementable financial stress index (FSI) is created and then used to illustrate the dramatic nature of the current crisis compared to earlier crises. We also examine how the global FSI might have been used to condition the exposure to the carry trade (long high interest rate currencies, short low interest rate currencies) and we show that such an index has potential value in protecting a portfolio against loss during periods of stress, although this result is subject to the important caveats of controlling for transaction costs and timely recognition of the change in regime.

Keywords: financial crisis, foreign exchange, exchange rates, transaction costs

JEL Classification: F30, F31

Suggested Citation

Melvin, Michael and Taylor, Mark P., The Crisis in the Foreign Exchange Market (July 2009). CESifo Working Paper Series No. 2707, Available at SSRN: https://ssrn.com/abstract=1437408

Michael Melvin (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Mark P. Taylor

Barclays - Barclays Global Investors (London) ( email )

Murray House
Royal Mint Court
EC3N 4HH London
United Kingdom

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