Attention to the Tail(s): Global Financial Conditions and Exchange Rate Risks

30 Pages Posted: 17 Sep 2019

Date Written: September 13, 2019

Abstract

We document how the entire distribution of exchange rate returns responds to changes in global financial conditions. We measure global financial conditions as the common component of country-specific financial condition indices, computed consistently across a large panel of developed and emerging economies. Based on quantile regression results, we provide a characterisation and ranking of the tail behaviour of a large sample of currencies in response to a tightening of global financial conditions, corroborating some of the prevailing narratives about safe haven and risky currencies. We then carry out a portfolio sorting exercise to identify the macroeconomic fundamentals associated with such different tail behaviour, and find that currency portfolios sorted on the basis of relative interest rates, current account balances and levels of international reserves display a higher likelihood of large losses in response to a tightening of global financial conditions.

Keywords: exchange rates, tail risks, financial conditions indices, global financial cycle, quantile regression

JEL Classification: F31, G15

Suggested Citation

Eguren Martin, Fernando and Sokol, Andrej, Attention to the Tail(s): Global Financial Conditions and Exchange Rate Risks (September 13, 2019). Bank of England Working Paper No. 822, September 2019. Available at SSRN: https://ssrn.com/abstract=3454782 or http://dx.doi.org/10.2139/ssrn.3454782

Fernando Eguren Martin (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Andrej Sokol

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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