The Crisis in the Foreign Exchange Market

Michael Melvin and Mark Taylor

No 2707, CESifo Working Paper Series from CESifo

Abstract: The financial crisis of 2007-2008 had major implications for the foreign exchange market. We review events and implications for exchange rates, volatility, returns to currency investing, and transaction costs. This “blow-by-blow” narrative is intended to be a resource for researchers seeking a comprehensive review of the “what, why and when” of the financial crisis in terms of foreign exchange market dynamics. An implementable financial stress index (FSI) is created and then used to illustrate the dramatic nature of the current crisis compared to earlier crises. We also examine how the global FSI might have been used to condition the exposure to the carry trade (long high interest rate currencies, short low interest rate currencies) and we show that such an index has potential value in protecting a portfolio against loss during periods of stress, although this result is subject to the important caveats of controlling for transaction costs and timely recognition of the change in regime.

Keywords: financial crisis; foreign exchange; exchange rates; transaction costs (search for similar items in EconPapers)
JEL-codes: F30 F31 (search for similar items in EconPapers)
Date: 2009
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (173)

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Related works:
Journal Article: The crisis in the foreign exchange market (2009)
Working Paper: The Crisis in the Foreign Exchange Market (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_2707

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