Beyond Incomplete Spanning: Convenience Yields and Exchange Rate Disconnect

55 Pages Posted: 25 May 2021 Last revised: 30 Aug 2022

See all articles by Zhengyang Jiang

Zhengyang Jiang

Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)

Arvind Krishnamurthy

Stanford Graduate School of Business; National Bureau of Economic Research (NBER); Stanford University - Stanford Institute for Economic Policy Research

Hanno N. Lustig

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

Jialu Sun

Northwestern University, Kellogg School of Management

Date Written: May 24, 2021

Abstract

We introduce safe asset demand for dollar-denominated bonds into a tractable incomplete-market model of exchange rates. The convenience yield on dollar bonds enters as a stochastic wedge in the Euler equations for exchange rate determination. This wedge reduces the pass-through from marginal utility shocks to exchange rate movements, resolving the exchange rate volatility puzzle. The wedge also exposes the dollar's exchange rate to convenience yield shocks, giving rise to exchange rate disconnect from macro fundamentals and a quantitatively important driver of currency risk premium. This endogenous exposure identifies a novel safe-asset-demand channel by which the Fed's QE impacts the dollar.

Keywords: Exchange Rate Puzzles, Dollar, Convenience Yields, Incomplete Markets

JEL Classification: E44, F31, G15

Suggested Citation

Jiang, Zhengyang and Krishnamurthy, Arvind and Lustig, Hanno N. and Sun, Jialu, Beyond Incomplete Spanning: Convenience Yields and Exchange Rate Disconnect (May 24, 2021). Stanford University Graduate School of Business Research Paper, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3852298 or http://dx.doi.org/10.2139/ssrn.3852298

Zhengyang Jiang

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

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

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Arvind Krishnamurthy

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Stanford University - Stanford Institute for Economic Policy Research ( email )

366 Galvez Street
John A. and Cynthia Fry Gunn Building
Stanford, CA CA 94305
United States

Hanno N. Lustig (Contact Author)

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

Jialu Sun

Northwestern University, Kellogg School of Management ( email )

Evanston, IL
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
428
Abstract Views
1,509
Rank
104,081
PlumX Metrics