Dollar Safety and the Global Financial Cycle

57 Pages Posted: 6 Feb 2019 Last revised: 12 Jul 2019

See all articles by Zhengyang Jiang

Zhengyang Jiang

Kellogg School of Management - Department of Finance

Arvind Krishnamurthy

Stanford Graduate School of Business

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Date Written: July 10, 2019

Abstract

U.S. monetary policy shocks have an outsized impact on the world economy, a phenomenon that is described by Rey’s (2013) “global financial cycle”. In contrast, shocks in foreign countries have smaller impacts on the U.S. We build a model to rationalize these facts based on the special demand for dollar safe assets. In the model, dollar safe assets trade at a premium: that is, they offer especially low returns. Banks and firms that have the collateral to issue dollar safe assets can collect this premium. U.S. institutions do so against dollar collateral, while foreign institutions do so against foreign currency collateral, taking on exchange rate risk in the process. U.S. monetary shocks impact the supply of dollar safe assets, affecting dollar safe assets’ premium and the dollar's value. This impact transmits across the globe and generates a global risk factor. We present evidence from movements in the Treasury basis to support the mechanism underlying our theory.

Keywords: Covered interest rate parity, exchange rates, safe asset demand, convenience yields

JEL Classification: F31

Suggested Citation

Jiang, Zhengyang and Krishnamurthy, Arvind and Lustig, Hanno N., Dollar Safety and the Global Financial Cycle (July 10, 2019). Stanford University Graduate School of Business Research Paper No. 19-16. Available at SSRN: https://ssrn.com/abstract=3328808 or http://dx.doi.org/10.2139/ssrn.3328808

Zhengyang Jiang (Contact Author)

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

HOME PAGE: http://https://sites.google.com/site/jayzedwye/

Arvind Krishnamurthy

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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