Dealer Leverage and Exchange Rates: Heterogeneity Across Intermediaries

50 Pages Posted: 27 Nov 2019

See all articles by Ricardo Correa

Ricardo Correa

Board of Governors of the Federal Reserve System

Laurie DeMarco

Board of Governors of the Federal Reserve System

Date Written: 2019-11-06

Abstract

In line with a growing literature on financial intermediary asset pricing, we find that changes in the leverage of primary dealers have predictive power in forecasting exchange rates. Unlike previous studies, we find that primary dealer heterogeneity matters for their role in asset pricing. The leverage of foreign-headquartered dealers in the United States entirely drive the predictive power on exchange rates, while the same measure for domestic U.S.-headquartered dealers is insignificant. The leverage of foreign-headquartered dealers also has more predictive power for some other assets. We argue that this heterogeneity is due to foreign broker-dealers having more balance sheet capacity relative to domestic dealers during the 2000s. This result conflicts with an assumption of homogeneity among intermediaries which is implicit in most modern intermediary asset pricing models. In addition, we find that currency market positions, including derivatives positions, are likely stronger than cross-border lending as the main channel through which leverage manifests itself in exchange rate changes.

Keywords: Exchange rates, Intermediaries, International finance, Leverage cycles, Primary dealers

JEL Classification: F30, F31, G12, G24

Suggested Citation

Correa, Ricardo and DeMarco, Laurie, Dealer Leverage and Exchange Rates: Heterogeneity Across Intermediaries (2019-11-06). FRB International Finance Discussion Paper No. 1262. Available at SSRN: https://ssrn.com/abstract=3494186 or http://dx.doi.org/10.17016/IFDP.2019.1262

Ricardo Correa (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Laurie DeMarco

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
13
Abstract Views
65
PlumX Metrics