Beyond Bilateral Flows: Indirect Connections and Exchange Rates

Saleem Bahaj, Pasquale Della Corte, Daniele Massacci and Eduard Seyde

No 19310, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper studies how cross-border financial connections affect the response of exchange rates to trade shocks. Theoretically, we develop a multi-country model whereby a country's exchange rate depends on the financiers' ability to manage capital flows between this country and its counterparties (direct connection) and between its counterparties and their trading partners (indirect connection). Empirically, we quantify the network of financial connections using granular data on cross-border claims and liabilities of globally active banks. Consistent with our theoretical predictions, we find that indirect connection can either amplify or mitigate the impact of trade shocks on future exchange rate returns, depending on the shock's origin and size, while direct connection always dampens these effects.

JEL-codes: F21 F30 F31 G12 G15 G21 (search for similar items in EconPapers)
Date: 2024-07
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