International Finance and Macroeconomics

Members of the NBER's International Finance and Macroeconomics Program met March 6 in Federal Reserve Bank of San Francisco. Faculty Research Fellow Cristina Arellano of Federal Reserve Bank of Minneapolis and Research Associate Oleg Itskhoki of Princeton University organized the meeting. These researchers' papers were presented and discussed:

Marcus Biermann, Université Catholique de Louvain, and Kilian Huber, University of Chicago

Tracing the International Transmission of a Crisis Through Multinational Firms

Biermann and Huber study how multinational firms transmit shocks across countries. They identify a lending cut by a single German bank, which reduced the credit supply of multinational parents located in Germany. Using detailed data on internal capital markets, they show that multinationals adjusted internal capital flows toward affected parents and away from international affiliates. Affiliate sales fell sharply and recovered after three years. The results indicate that preexisting internal capital market positions can be used to predict the degree of cross-country shock transmission and that idiosyncratic shocks to lending by a single "granular" bank in a single country affect growth internationally.

Gianluca Benigno, London School of Economics; Andrew Foerster, Federal Reserve Bank of San Francisco; Christopher Otrok, University of Missouri; and Alessandro Rebucci, Johns Hopkins University and NBER

The Anatomy of Crises and Cycles in Mexico: An Endogenous Regime Switching Approach Benigno, Foerster, Otrok, and Rebucci propose a new approach to specifying and solving DSGE models with occasionally binding collateral constraints. The specification of the collateral constraint that they suggest assumes that the transition from the unconstrained to the constrained state is a stochastic rather than a deterministic function of the endogenous level of leverage. This formulation results in an endogenous regime-switching model that can be solved with perturbation methods. Next, using Bayesian full information methods, the researchers estimate a model with an occasionally binding constraint in the spirit of Mendoza (AER 2010), with Mexican quarterly data since 1981, considering a comprehensive set of shocks as in Garcia-Cicco et. al. (AER 2010). They find that the estimated model fits the data well, characterizing both their second moments and the 1995 Tequila crisis period. It yields estimates of the regime probabilities that align well with the narrative of Mexico's financial crisis history. The researchers also find that a cocktail of shocks that co-move in an adverse manner, rather than a sequence of large negative shocks with a negative correlation between the productivity and the interest rate shock as typically assumed in the extant literature, precedes large sudden stops episodes. Finally, the researchers document that expenditure and impatience shocks drove Mexico's economy into the Tequila crisis, while productivity and interest shocks prevailed during that particular sudden stop episode.

Gastón Chaumont, University of Rochester

Sovereign Debt, Default Risk, and the Liquidity of Government Bonds

The secondary market for sovereign bonds is illiquid and the liquidity is endogenous. Such endogenous liquidity has important effects on the credit spread and the probability of default. To study equilibrium implications of such liquidity, Chaumont integrates directed search in the secondary market into a macro model of sovereign default. The model generates liquidity endogenously because investors in the secondary market face a trade-off between the transaction costs and the trading probability. This trade-off varies with the aggregate state of the economy, creating a time-varying liquidity premium over the business cycle. Chaumont shows that trade flows in the secondary market significantly affect the price of sovereign bonds and amplify the effect of default risk on credit spreads. The importance of liquidity in the secondary market increases when the economic conditions of the issuing country worsen. Illiquidity increases with default risk and accounts for a sizable fraction of credit spreads, ranging from 10% to 50%.

Sofonias Korsaye and Fabio Trojani, University of Geneva, and Andrea Vedolin, Boston University and NBER

The Global Factor Structure of Exchange Rates

Korsaye, Trojani, and Vedolin provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate model-free global stochastic discount factors (SDFs) pricing large cross-sections of international assets, such as stocks, bonds, and currencies, independently of the currency denomination and in the presence of trading frictions. They derive a unique mapping between the optimal portfolios of global investors trading in international markets with frictions and international SDFs, which allows us to recover global SDFs from asset return data alone. Trading frictions shrink portfolio weights of some assets to zero, leading to endogenously segmented markets and robust properties of international SDFs. From the cross-section of numéraire invariant SDFs, we extract global exchange rate factors and show that they are strongly related to dollar and carry. Using these factors, the researchers obtain an excellent in- and out-of-sample fit of up to 80% for the cross-section of international asset returns, significantly improving upon the performance of benchmark factor models. Finally, Korsaye, Trojani, and Vedolin estimate the cost to obtain the portfolio home bias observed in the data and find it to be small.

Vania Stavrakeva, London Business School, and Jenny Tang, Federal Reserve Bank of Boston

Deviations from FIRE and Exchange Rates: A GE Theory of Supply and Demand

Stavrakeva and Tang build a general equilibrium model that takes the institutional details of the foreign exchange market into account and allows for deviations from full information rational expectations (FIRE) in a way consistent with forecast survey data and positions. They show that the testable implications of this model -- related to foreign exchange derivatives positions, and both realized and expected exchange rates--are strongly supported in the data. Moreover, the researchers argue that the particular form of deviation from FIRE implied by the data can help resolve important exchange rate puzzles, such as the Fama puzzle and the delayed overshooting puzzle, and can generate hump-shaped dynamics of exchange rates.

Konstantin Egorov, New Economic School, and Dmitry Mukhin, University of Wisconsin-Madison

Optimal Monetary Policy under Dollar Pricing The recent empirical evidence shows that most international prices are sticky in dollars. Egorov and Mukhin study the optimal monetary policy and the welfare implications of dollar pricing in a context of an open economy model with nominal rigidities and establishes the following results: 1) while monetary policy is less efficient and cannot implement the flexible-price allocation, inflation targeting remains robustly optimal in non-US economies, 2) the implementation of this policy results in the "global monetary cycle" with other countries partially pegging their exchange rates to the dollar, 3) unilateral capital controls do not help to restore the efficient allocation, 4) optimal US policy deviates from inflation targeting and partially internalizes the international spillovers on global economy, 5) the issuer of the dominant currency achieves a higher welfare than other economies, which can in turn benefit from forming a currency union such as the Eurozone.

Alyssa G. Anderson and Bernd Schlusche, Federal Reserve Board, and Wenxin Du, University of Chicago and NBER, "Arbitrage Capital of Global Banks"

Arbitrage Capital of Global Banks

The role of unsecured short-term wholesale funding for global banks' operations has changed significantly in the post-crisis regulatory environment. Anderson, Du, and Schlusche show that global banks mainly use unsecured wholesale funding to finance persistent near risk-free arbitrage positions post-crisis, in particular, the interest on excess reserves arbitrage and the covered interest rate parity arbitrage. Under this business model, they examine the effects of a large negative wholesale funding shock for global banks as a result of the US money market mutual fund reform implemented in 2016. The researchers find that the primary response of global banks to the reform was a cutback in arbitrage positions that relied on unsecured funding, rather than a reduction in loan provision. Furthermore, the researchers examine the relationship between arbitrage capital and arbitrage profits.

NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us