Currency returns and FX dealer balance sheets

Stefan Reitz and Dennis Umlandt

Journal of International Economics, 2021, vol. 133, issue C

Abstract: We show that excess returns to the carry trade can be interpreted as compensation for foreign exchange dealers’ capital risk. Given that the top market makers in foreign exchange are at the heart of the market's information aggregation process we also suggest that it is their marginal value of wealth which prices FX portfolio returns. Consistent with this hypothesis the empirical results show that shocks to the equity capital ratios of the top three foreign exchange dealers have explanatory power for the cross-sectional variation in expected currency returns, while those of the average dealer provide no substantial additional information.

Keywords: Carry trades; FX dealers; Currency pricing; Balance sheet risk (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:133:y:2021:i:c:s0022199621001215

DOI: 10.1016/j.jinteco.2021.103541

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