Financial Amplification of Foreign Exchange Risk Premia - Federal Reserve Bank of New York

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Staff Reports

Financial Amplification of Foreign Exchange Risk Premia

July 2010 Number 461
Revised: January 2011

JEL classification: G15, G01, G17, F31

Authors: Tobias Adrian, Erkko Etula, and Jan J. J. Groen

Theories of financial frictions in international capital markets suggest that financial intermediaries’ balance-sheet constraints amplify fundamental shocks. We present empirical evidence for such theories by decomposing the U.S. dollar risk premium into components associated with macroeconomic fundamentals and a component associated with financial intermediary balance sheets. Relative to the benchmark model with only macroeconomic state variables, balance sheets amplify the U.S. dollar risk premium. We discuss applications to financial stability monitoring.

Available only in PDF pdf

31 pages / 305 kb

For a published version of this report, see Tobias Adrian, Erkko Etula, and Jan J. J. Groen, "Financial Amplification of Foreign Exchange Risk Premia," European Economic Review 55, no. 3 (April 2011): 354-70.

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