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Session 12: The Dollar’s Special Status

September 5-7, 2019 | Landau Economics Bldg, 579 Serra Mall, Room 134 (A), Stanford

The U.S. dollar plays a unique role as the major reserve currency in the international financial system. The dollar’s status also creates special demand by foreign investors for safe assets denominated in dollars. This SITE session invite papers that explore why the dollar plays this role, and how the dollar’s special status affects exchange rate valuation, international capital flows, the trade balance, etc. We are also interested in papers that explore the role of financial intermediaries in currency markets.

Organizers: Arvind Krishnamurthy (Stanford Graduate School of Business), Hanno Lustig (Stanford Graduate School of Business) and Matteo Maggiori (Harvard University)

In this Session

Sep 5 | 8:30 am to 9:00 am

Check-in | Breakfast

Sep 5 | 9:00 am to 9:45 am

Exchange Rates and Asset Prices in a Global Demand System

Presented by: Moto Yogo (Princeton)
Co-Author(s): Ralph Koijen (Chicago Booth)

Using cross-country holdings, we estimate a demand system for financial assets across 36 countries. Based on the estimated demand system and market clearing, we decompose exchange rates, long-term yields, and equity prices into three sources of variation: macro variables, policy variables (i.e., short-term rates, debt quantities, and foreign exchange reserves), and latent demand. The former two account for 58 percent of the variation in exchange rates, and the remaining variation due to latent demand is geographically concentrated. Policy variables account for 66 percent of the variation in long-term yields. Macro variables account for 63 percent of the variation in equity prices.

Sep 5 | 9:45 am to 10:00 am

Break

Sep 5 | 10:00 am to 10:45 am

A Theory of Term Premiums and Exchange Rates

Presented by: Adi Sunderam (Harvard)
Co-Author(s): Robin Greenwood (Harvard), Sam Hanson (Harvard) and Jeremy Stein (Harvard)
Sep 5 | 10:45 am to 11:15 am

Break

Sep 5 | 11:15 am to 12:00 pm

Credit Supply and Household Debt: Evidence from Brazil

Presented by: Amir Sufi (University of Chicago)
Co-Author(s): Atif Man (Princeton) and Jacopo Ponticelli (Northwestern)
Sep 5 | 12:00 pm to 1:35 pm

Lunch

Sep 5 | 1:35 pm to 2:30 pm

Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens

Presented by: Matteo Maggiori (Harvard)
Co-Author(s): Antonio Coppola (Harvard), Brent Neiman (University of Chicago) and Jesse Schreger (Columbia)
Sep 5 | 2:30 pm to 3:00 pm

Break

Sep 5 | 3:00 pm to 3:55 pm

The International Medium of Exchange

Presented by: Rosen Valchev (Boston College)
Co-Author(s): Ryan Chahrour (Boston College)

We propose a model of endogenous, persistent coordination on the international medium of exchange. An asset becomes the dominant international medium because it is widely held, and remains widely held because it is dominant. The country issuing the dominant asset is a net debtor, but earns an “exorbitant privilege” on its position. In a calibrated model, only steady states with one dominant asset are stable. The dominant country experiences a significant welfare gain, most of which is accrued during its rise to dominance. A mild trade war reduces privilege slightly, while a protracted or deep trade war eliminates it altogether.

Sep 5 | 3:55 pm to 4:25 pm

Break

Sep 5 | 4:25 pm to 5:20 pm

Banks, Dollar Liquidity, and Exchange Rates

Presented by: Saki Bigio (UCLA)
Co-Author(s): Javier Bianchi (MPLS Fed) and Charles Engel (UWM)
Sep 5 | 6:00 pm

Dinner

Sep 6 | 8:30 am to 9:00 am

Breakfast

Sep 6 | 9:00 am to 10:00 am

External Debt, Currency Risk, and International Monetary Policy Transmission

Presented by: Ursula Wiridianata (International Monetary Fund)

I argue that countries’ U.S.-dollar-denominated net external debt (dollar debt) helps to explain the large differences in risk premia across currencies and how U.S. monetary policy affects the global economy. When the U.S. dollar strengthens, the real value of dollar debt increases, weakening the currencies of countries with large amounts of dollar debt. As the dollar tends to strengthen after bad news, highdollar-debt currencies are bad hedges and hence have to offer high risk premia. My empirical findings support this idea. First, dollar debt captures the response of exchange rates and issuance of new debt to U.S. monetary policy shocks. Second, dollar debt captures the cross sectional variation in average currency excess returns in anticipation of FOMC announcements, as well as average currency excess returns in general. Finally, I develop a general equilibrium model with financial frictions and currency choice of debt denomination that corroborates my findings.

Sep 6 | 10:00 am to 10:15 am

Break

Sep 6 | 10:15 am to 11:15 am

Global Investors, the Dollar, and U.S. Credit Conditions

Presented by: Tim Schmidt-Eisenlohr (Federal Reserve Board)
Co-Author(s): Friederike Niepmann (Federal Reserve Board)
Sep 6 | 11:15 am to 11:30 am

Break

Sep 6 | 11:30 am to 12:30 pm

Credit Migration and Covered Interest Rate Parity

Presented by: Gordon Liao (Federal Reserve Board)

This paper examines the connection between deviations in covered interest rate parity and dierences in the credit spread of bonds of similar risk but dierent currency denomination. These two pricing anomalies are highly aligned in both the time series and the cross-section of currencies. The composite of these two pricing deviations the corporate basis represents the currency-hedged borrowing cost dierence between currency regions and explains up to a third of the variation in the aggregate corporate debt issuance ow. I show that arbitrage aimed at exploiting one type of security anomaly can give rise to the other.

Sep 6 | 12:30 pm to 1:30 pm

Lunch

Sep 6 | 1:30 pm to 2:30 pm

Are Intermediary Constraints Priced?

Presented by: Ben Hebert (Stanford)
Co-Author(s): Wenxin Du (University of Chicago) and Amy W. Huber (Stanford)

Violations of no-arbitrage conditions measure the shadow cost of constraints on intermediaries, and the risk that these constraints tighten is priced. We demonstrate in an intermediary-based asset pricing model that violations of no-arbitrage such as covered interest rate parity (CIP) violations, along with intermediary wealth returns, can be used to price assets. We describe a “forward CIP trading strategy” that bets on CIP violations becoming smaller, and show that its returns help identify the price of the risk that the shadow cost of intermediary constraints increases. This risk contributes substantially to the volatility of the stochastic discount factor, and appears to be priced consistently in U.S. treasury, emerging market sovereign bond, and foreign exchange portfolios.

Sep 6 | 2:30 pm to 2:45 pm

Break

Sep 6 | 2:45 pm to 3:45 pm

US Fiscal Cycle and the Dollar

Presented by: Zhengyang Jiang (Northwestern)

I develop a VAR framework to estimate the term structure of the dollar’s risk premium and attribute its variation to various sources. The term structure varies significantly over time, accounts for the dollar’s exchange rate movement, and comoves with US equity and bond risk premia. While the dollar’s short-term risk premium loads on the US fiscal cycle, interest rate differential, liquidity premium and the real exchange rate, its long-term risk premium only loads on the US fiscal cycle. When I compare the term structure dynamics with leading asset pricing models, a new volatility puzzle emerges.

Sep 6 | 3:45 pm to 4:00 pm

Break

Sep 6 | 4:00 pm to 5:00 pm

Currency Choice in Contracts

Presented by: Andres Drenik (Columbia)
Sep 6 | 6:00 pm

Dinner

Sep 7 | 7:30 am to 8:00 am

Breakfast

Sep 7 | 8:00 am to 9:00 am

Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy

Presented by: Carolin Pflueger (University of Chicago)
Co-Author(s): Wenxin Du (University of Chicago) and Jesse Schreger (Columbia Business School)

We document that governments whose local currency debt provides them with greater hedging benefits actually borrow more in foreign currency. We introduce two features into a  government's debt portfolio choice problem to explain this finding: risk-adverse lenders and lack of monetary policy commitment. A government without commitment chooses excessively counter-cyclical inflation ex post, which leads risk-adverse leaders to require a risk premium ex ante. This makes local currency debt too expensive from the local government's perspective and thereby discourages the government from borrowing its own currency.

Sep 7 | 9:00 am to 9:15 am

Break

Sep 7 | 9:15 am to 10:15 am

Dominant Currency Debt

Presented by: Malamud Semyon (Ecole Polytechnique Fédérale de Lausanne)
Co-Author(s): Egemen Eren (Bank for International Settlements)

We propose a “debt view” to explain the dominant international role of the dollar. We develop an international general equilibrium model in which firms optimally choose the currency composition of their debt. Theoretically, the dominant currency is the one that depreciates in global downturns over horizons of corporate debt maturity. Empirically, the dollar fits this description, despite being a short-run safe-haven currency. We provide broad empirical support for the debt view. We also study the globally optimal monetary policy.

Sep 7 | 10:15 am to 10:30 am

Break

Sep 7 | 10:30 am to 11:30 am

Determinants of Sovereign Local Currency Bond Yields: The Case of Asia-Pacific

Presented by: Mikhail Chernov (UCLA)
Co-Author(s): Drew Creal (Notre Dame) and Peter Hoerdahl (BIS)
Sep 7 | 11:30 am to 11:45 am

Break

Sep 7 | 11:45 am to 12:45 pm

Which Investors Matter for Global Equity Valuations and Expected Returns?

Presented by: Robert Richmond (NYU)
Co-Author(s): Ralph S. Koijen (University of Chicago, Booth School of Business) and Motohiro Yogo (Princeton University)