Market Incompleteness and Exchange Rate Spill-over

54 Pages Posted: 8 Jun 2021 Last revised: 26 Apr 2024

Multiple version iconThere are 2 versions of this paper

Date Written: June 7, 2021

Abstract

Financial variables in third countries explain a significant fraction of bilateral exchange rate movements, even after local variables and common factors are controlled for. This paper proposes an explanation of this exchange rate spill-over pattern based on market incompleteness, which arises when agents in different countries bear different exposures to foreign risks, while the asset space is not complete enough to hedge out these risks. This mechanism weakens the link between exchange rates and local fundamentals, and generates additional exchange rate variations and comovements. To study bilateral exchange rates, it is not sufficient to consider only the local conditions.

Keywords: Incomplete Markets, Exchange Rate Disconnect, Currency Factors

JEL Classification: F31, F44, G15

Suggested Citation

Jiang, Zhengyang, Market Incompleteness and Exchange Rate Spill-over (June 7, 2021). Available at SSRN: https://ssrn.com/abstract=3861805 or http://dx.doi.org/10.2139/ssrn.3861805

Zhengyang Jiang (Contact Author)

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

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