Currency and Sovereign Risks Across Borders
Paper Session
Saturday, Jan. 3, 2026 2:30 PM - 4:30 PM (EST)
- Chair: Chang He, University of Virginia
U.S. Liquid Government Liabilities and Emerging Market Capital Flows
Abstract
Empirical work finds that flows of investments from the U.S. and other high income countries to emerging markets increase during times of quantitative easing (QE) by the U.S. Federal Reserve, and the reverse movement occurs under quantitative tightening. We offer new evidence to confirm these findings, and then propose a theory based on the liquidity of U.S. government liabilities held by the public. We hypothesize that QE, by increasing liquidity, offers greater flexibility for investors that might be concerned their funds will be tied up when shocks to income or investment opportunities arise. With the assurance that some of their portfolio can be readily sold in liquid markets, rich country investors are more willing to increase investments in illiquid loans to emerging markets. The effect of increasing the liquidity of U.S. government liabilities on investments in EMs may even be stronger during times of greater uncertainty. We find evidence to support our interpretation: QE lowers covered interest parity deviations for the dollar, as our model predicts.Value-at-Risk Constraints, Robustness, and Aggregation
Abstract
I describe a value-at-risk constraint that induces long-lived investors to choose static mean-variance portfolios with time-varying risk tolerance. This allows incorporating risk aversion shocks into dynamic models while keeping portfolios easy to aggregate across heterogeneous investors. In equilibrium, asset prices follow standard risk-neutral pricing equations with one additional term that depends on the wealth distribution through a single scalar. I provide a foundation for the value-at-risk constraint through a version of robustness concerns, where investors fear model misspecification and try to account for adverse alternative scenarios. I then illustrate the practicality of value-at-risk in a sovereign debt model with a cross-section of countries. Aggregate shocks to lenders’ constraints create endogenous pricing risk, global interest rate risk, and a volatile common component in spreads that is orthogonal to fundamentals. I show that, despite this rich upside, solving for global equilibria with value-at-risk constraints requires minimal departures from models with risk-neutral lenders.Foreign Exchange Risk Management Spillovers Across the Production Network
Abstract
This paper uncovers the substantial foreign exchange risks faced by U.S. firms, despite most international trade being invoiced in U.S. dollars. These risks arise due to spillovers through the production network and fluctuations in foreign demand when exchange rates change. Using new hand-collected data from firms’ annual reports, I document that U.S. firms actively hedge foreign exchange risks using financial derivatives. I develop the first model of hedging in a production network and show that hedging by upstream or downstream firms can stabilize a firm’s performance due to shared risk exposures. This positive spillover effect operates through firms’ financial constraints: hedging stabilizes firms’ borrowing costs and the prices they charge connected firms. Exploiting two major USD–Euro exchange rate swings, I find that hedging by connected firms is as effective as a firm’s own hedging in stabilizing performance. Additionally, firms at the extremities of the production and trade network are more likely to hedge. Calibrating the model to U.S. data, I show that these spillover effects boost aggregate output and reduce prices.JEL Classifications
- F3 - International Finance
- G0 - General