This paper provides an empirical test of the scapegoat theory of exchange rates van Wincoop 2004, 2011), as an attempt to evaluate its potential for explaining the poor empirical performance of traditional exchange rate models. This theory suggests that market participants may at times attach signi…cantly more weight to individual economic fundamentals to rationalize the pricing of currencies, which are partly driven by unobservable shocks. Using novel survey data which directly measure foreign exchange scapegoats for 12 currencies and a decade of proprietary data on order ‡ow, we …nd empirical evidence that strongly supports the empirical implications of the scapegoat theory of exchange rates, with the resulting models explaining a large fraction of the variation and directional changes in exchange rates. The …ndings have implications for exchange rate modelling, suggesting that a more accurate understanding of exchange rates requires taking into account the role of scapegoat factors and their time-varying nature.

Using a unique dataset that covers UK defined-benefit pension fund asset allocations over the past 25 years, we provide robust evidence that pension funds display strong herding behavior, and tend to herd in subgroups defined by fund size and sponsor type. We also show that, while pension funds tend to switch from equities to bonds as their liabilities mature, they mechanically rebalance their portfolios in the short term. Finally, we find that their price impact is neither persistent nor stabilizing, and that there are only small cross-sectional differences in returns across pension funds, consistent with their widespread herding behavior.

We develop a multivariate credit risk model that accounts for joint defaults of banks and allows us to disentangle how much of banks’ credit risk is systemic. We find that the United States and United Kingdom differ not only in the evolution of systemic risk but, in particular, in their banks’ systemic exposures. In both countries, however, systemic credit risk varies substantially, represents about half of total bank credit risk on average, and induces high risk premia. The results suggest that sovereign and bank systemic risk are particularly interlinked in the United Kingdom.

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