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Macro-Finance: Collateral and Currency Markets

Paper Session

Friday, Jan. 4, 2019 10:15 AM - 12:15 PM

Atlanta Marriott Marquis, International 8
Hosted By: American Economic Association
  • Chair: Ryan Chahrour, Boston College

International Medium of Exchange: Privilege and Duty

Ryan Chahrour
,
Boston College
Rosen Valchev
,
Boston College

Abstract

The United States enjoys an “exorbitant privilege” that allows it to borrow at lower interest rates than the rest of the world. Meanwhile, the dollar plays a special role in the international financial system as the main international medium of exchange. We provide a new model where these two phenomena are linked and arise endogenously, through the need for an international medium of exchange. We consider a two-country world where international trade happens in decentralized matching markets, and must be collateralized by assets — a.k.a. currencies — issued by one of the two countries. Traders have an incentive to coordinate their currency choices and a single dominant currency arises in equilibrium. With a small heterogeneity in traders’ information, the equilibrium currency choice is unique, given economic states. Nevertheless, due to feedback between the trading firms’ currency choices and the households’ portfolio decisions, the model has multiple steady states, where different currencies serve as the dominant international medium of exchange. The economy with the dominant currency enjoys lower interest rates and the ability to run current account deficits indefinitely. Currency regimes are stable as they are not subject to sunspots, but sufficiently large shocks or policy changes can lead to transitions from one steady state to another, with large welfare implications.

Foreign Safe Asset Demand and the Dollar Exchange Rate

Zhengyang Jiang
,
Northwestern University
Hanno Lustig
,
Stanford University and NBER
Arvind Krishnamurthy
,
Stanford University and NBER

Abstract

We develop a theory that links foreign investors' demand for the safety of U.S. Treasury bonds to the value of the dollar in spot markets. An increase in the convenience yield that foreign investors derive from holding U.S. Treasury’s induces an immediate appreciation of the US dollar and, going forward, lowers the expected return to a foreign investor from owning Treasury bonds. Under our theory, we show that the foreign convenience yield can be measured by the `Treasury basis,' defined as the wedge between the yield on foreign government bonds and the currency-hedged yield on U.S. Treasury bonds. We measure the convenience yield using data from a cross-country panel going back to 1988 and the US/UK cross going back to 1970. In both datasets, regression evidence strongly supports the theory. Our results help to resolve the exchange rate disconnect puzzle: The Treasury basis variation accounts for up to 41% of the quarterly variation in the dollar. Our results also provide support for recent theories which ascribe a special role to the U.S. as a provider of world safe assets.

Collateral Booms and Information Depletion

Vladimir Asriyan
,
Pompeu Fabra University
Luc Laeven
,
European Central Bank and CEPR
Alberto Martin
,
CREI, Pompeu Fabra University, and Barcelona GSE

Abstract

We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral
values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model's main mechanism.

Exchange Rate Supply and Demand: Who Moves Exchange Rates?

Vania Stavrakeva
,
London Business School
Jenny Tang
,
Federal Reserve Bank of Boston

Abstract

Exchange rates, as any other market-driven price, are determined by an equilibrium of supply and demand. Based on a model of currency derivatives markets with heterogeneous agents, which is strongly supported by the data, we present a novel empirical exchange rate decomposition. Using this model, we can attribute most of the variation in exchange rate changes to broker-dealer clients' currency expectations and hedging demand for over-the-counter currency derivative contracts and, to a lesser extent, to momentum trading by speculators in currency futures markets. We use this decomposition to shed light on the key drivers behind policy-relevant exchange rate movements such as the appreciation of the US dollar at the onset of the Global Financial Crisis.

Paper available at: https://www.dropbox.com/s/4qfzv8fgx2n8awi/StavrakevaTang2018_SupplyDemand.pdf
Discussant(s)
Adrien Verdelhan
,
Massachusetts Institute of Technology and NBER
Dongho Song
,
Johns Hopkins Carey Business School
Ozge Akinci
,
Federal Reserve Bank of New York
Andrea Vedolin
,
Boston University
JEL Classifications
  • F4 - Macroeconomic Aspects of International Trade and Finance
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit