Exchange Rate Reconnect
34 Pages Posted: 7 Jul 2019 Last revised: 18 Dec 2019
There are 4 versions of this paper
Exchange Rate Reconnect
Exchange Rate Reconnect
Exchange Rate Reconnect
Exchange Rate Reconnect
Date Written: June 30, 2019
Abstract
It is surprisingly difficult to find economic variables that strongly co-move with exchange rates, a phenomenon codified in a large literature on ``exchange rate disconnect.'' We demonstrate that a variety of common proxies for global risk appetite, which did not co-move with exchange rates prior to 2007, have provided significant in-sample explanatory power for currencies since then. Furthermore, during the global financial crisis and its aftermath, U.S. purchases of foreign bonds were highly correlated with these risk measures as well as with exchange rates. Changes in this type of capital flow statistically explain as much as half of the quarterly variation in the US dollar during 2007-2012. We use security-level data on U.S. portfolios to demonstrate that this connection of U.S. foreign bond purchases to exchange rates is largely driven by investment in dollar-denominated assets rather than by foreign currency exposure alone. Our results support the narrative emerging from an active recent literature that the US dollar's role as an international and safe-haven currency has surged since the global financial crisis.
Keywords: Capital Flows, Risk, Exchange Rates, Reserve Currencies
JEL Classification: E42, E44, F3, F55, G11, G15, G23, G28
Suggested Citation: Suggested Citation