DeFiPP Research Seminar by Jankte De Boer (Ruhr University Bochum)

FX Dealer Constraints and External Imbalances

Abstract:

We empirically test the theoretical prediction of Gabaix and Maggiori (2015) that currencies are repriced according to the country's external capital dependence when financial constraints of FX intermediaries change. Using market-based solvency indicators from 2004 to 2021, we develop a novel intermediary constraints index that captures the risk-bearing capacity of major FX intermediaries. We find that FX dealer constraints are a priced risk factor in currency portfolios that are sorted on countries' net foreign assets. Our results imply higher (lower) intermediary risk premia for currency portfolios of net external debtors (creditors), which pay lower (higher) returns when constraints tighten. Tightening constraints are associated with currency depreciation of countries with low net foreign assets, particularly emerging markets and countries with large outstanding net debt and low foreign exchange reserves.

 

Contact : Romain Houssa - Romain.Houssa@unamur.be
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