Global liquidity and exchange rates

Tobias Adrian (), Erkko Etula () and Hyun Song Shin

No 361, Staff Reports from Federal Reserve Bank of New York

Abstract: We present evidence that fluctuations in the aggregate balance sheets of financial intermediaries forecast exchange rate returns - at weekly, monthly, and quarterly frequencies, both in and out of sample, and for a large set of countries. We estimate prices of risk using a cross-sectional, arbitrage-free asset pricing approach and show that balance sheets forecast exchange rates because of the latter's association with fluctuations in risk premia. We provide a rationale for an intertemporal equilibrium pricing theory in which intermediaries are subject to balance sheet constraints.

Keywords: Intermediation (Finance); Asset pricing; Foreign exchange rates; International finance; Financial institutions; Investment banking (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-opm
Date: 2009
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