Dealer Leverage and Exchange Rates: Heterogeneity Across Intermediaries

Ricardo Correa and Laurie Pounder DeMarco
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Laurie Pounder DeMarco: https://www.federalreserve.gov/econres/laurie-pounder-demarco.htm

No 1262, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: In line with a growing literature on financial intermediary asset pricing, we find that changes in the leverage of primary dealers have predictive power in forecasting exchange rates. Unlike previous studies, we find that primary dealer heterogeneity matters for their role in asset pricing. The leverage of foreign-headquartered dealers in the United States entirely drive the predictive power on exchange rates, while the same measure for domestic U.S.-headquartered dealers is insignificant. The leverage of foreign-headquartered dealers also has more predictive power for some other assets. We argue that this heterogeneity is due to foreign broker-dealers having more balance sheet capacity relative to domestic dealers during the 2000s. This result conflicts with an assumption of homogeneity among intermediaries which is implicit in most modern intermediary asset pricing models. In addition, we find that currency market positions, including derivatives positions, are likely stronger than cross-border lending as the main channel through which leverage manifests itself in exchange rate changes.

Keywords: Exchange rates; Intermediaries; International finance; Leverage cycles; Primary dealers (search for similar items in EconPapers)
JEL-codes: F30 F31 G12 G24 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2019-11-06
New Economics Papers: this item is included in nep-ban and nep-cfn
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:1262

DOI: 10.17016/IFDP.2019.1262

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