Risk capacity, portfolio choice and exchange rates

24 Pages Posted: 9 Feb 2022

See all articles by Boris Hofmann

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department

Ilhyock Shim

Bank for International Settlements (BIS)

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: February 6, 2022

Abstract

We lay out a model of risk capacity for global portfolio investors in which swings in exchange rates can affect their risk-taking capacity in a Value-at-Risk framework. Exchange rate fluctuations induce shifts in portfolio holdings of global investors, even in the absence of currency mismatches on the part of the borrowers. A currency appreciation for an emerging market borrower that is part of a broad-based appreciation of emerging market currencies leads to larger bond portfolio inflows than the equivalent appreciation in the absence of a broad-based appreciation. As such, the broad dollar index emerges as a global factor in bond portfolio flows. The empirical evidence strongly supports the predictions of the model.

Keywords: Bond spread, capital flow, credit risk, emerging market, exchange rate

JEL Classification: G12, G15, G23

Suggested Citation

Hofmann, Boris and Shim, Ilhyock and Shin, Hyun Song, Risk capacity, portfolio choice and exchange rates (February 6, 2022). Available at SSRN: https://ssrn.com/abstract=4028446 or http://dx.doi.org/10.2139/ssrn.4028446

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Ilhyock Shim

Bank for International Settlements (BIS) ( email )

78F, Two International Finance Centre
8 Finance Street, Central
Hong Kong, n/a n/a
Hong Kong

HOME PAGE: http://www.bis.org/author/ilhyock_shim.htm

Hyun Song Shin (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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