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  5. Asset Pricing: International Finance
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Asset Pricing: International Finance

Paper Session

Sunday, Jan. 7, 2024 8:00 AM - 10:00 AM (CST)

Marriott Rivercenter, Grand Ballroom Salon B
Hosted By: American Finance Association
  • Chair: Juliana Salomao, University of Minnesota

Dollar Asset Holding and Hedging Around the Globe

Amy Huber
,
University of Pennsylvania
Wenxin Du
,
Columbia University

Abstract

We analyze a large number of industry- and company-level filings of global institutional investors to provide the first comprehensive estimate of foreign investors' U.S. dollar (USD) security holdings and currency hedging practices. We document three stylized facts. First, driven by growing portfolio allocations, foreign investors increased their holdings of USD securities by six-fold in the past two decades. Second, after the financial crisis of 2007-09, foreign investors increased their USD hedge ratio by 15 percentage points on average, despite higher hedging costs implied by large and persistent deviations from covered-interest rate parity. Third, there is considerable heterogeneity in hedging practice across countries and sectors. We develop a simple mean-variance framework to examine the drivers of currency hedging, and show empirically that hedging demand significantly deviates from the mean-variance framework. Furthermore, hedging demand is strongly correlated with the cross-section of CIP deviations.

Can Time Varying Currency Risk Hedging Explain Exchange Rates?

Leonie Braeuer
,
University of Geneva
Harald Hau
,
Geneva Finance Research Institute

Abstract

The rise in net international bond positions of non-US investors over the last decade can account for the long-run surge in net dollar hedging positions in FX derivatives. The latter influence spot exchange rates through CIP arbitrage. Using intermediaries’ capital ratio as a supply shifter, we identify a price inelastic derivative demand by institutional investors and document that changes in their net hedging positions can explain approximately 30% of all monthly variation in the seven most important dollar exchange rates from 2012 to 2022.

Understanding the Strength of the Dollar

Zhengyang Jiang
,
Northwestern University
Robert Richmond
,
New York University
Tony Zhang
,
Federal Reserve Board

Abstract

We explain variation in the strength of the U.S. dollar with capital flows driven by primitive economic factors. Prior to the global financial crisis, global savings and demand shifts depreciated the dollar, whereas they appreciated it after. Interest rates impacted the dollar’s value over short horizons, but declined in significance over longer horizons as rates converged. Our estimates imply that the dollar’s value is stable even when one foreign country unilaterally sells its U.S. assets. However, a weakening global demand for U.S. assets of the same magnitude as the early 2000s could significantly depreciate the dollar.

What Do Financial Markets Say About the Exchange Rate?

Mikhail Chernov
,
University of California-Los Angeles
Valentin Haddad
,
University of California-Los Angeles
Oleg Itskhoki
,
University of California-Los Angeles

Abstract

Financial markets play two roles with implications for the exchange rate: they accommodate risk-sharing and act as a source of shocks. In prevailing theories, these roles are seen as mutually exclusive and individually face challenges in explaining exchange rate dynamics. However, we demonstrate that this is not necessarily the case. We develop an analytical framework that characterizes the link between exchange rates and finance across all conceivable market structures. Our findings indicate that full market segmentation is not necessary for financial shocks to explain exchange rates. Moreover, risk-sharing can have a significant role without leading to the traditional puzzles associated with the macro disconnect. We identify plausible market structures where both roles coexist, addressing challenges faced when examined separately.

Discussant(s)
Tony Zhang
,
Federal Reserve Board
Falk Braeuning
,
Federal Reserve Bank of Boston
Antonio Coppola
,
Stanford University
Moritz Lenel
,
Princeton University
JEL Classifications
  • G1 - General Financial Markets