International Currencies and Capital Allocation

Abstract

for excellent research assistance. Our analysis makes use of data that are proprietary to Morningstar and/or its content providers. Neither Morningstar nor its content providers are responsible for any of the views expressed in this article. We thank the Becker-Friedman Institute, the NSF (1653917), the Sloan Foundation, and the Weatherhead Center for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Dominant Currency Paradigm

“…Taking a step back, our paper con rms that the dominance of the U.S. dollar is pervasive, from the structure of external balance sheets (Gourinchas and Rey (2014)), the currency composition of private portfolios (Maggiori et al (2018)), the choice of anchor currency (Ilzetzki et al (2017) and trade invoicing, with important and complex interactions which we are only starting to explore (e.g., Gopinath and Stein (2018)).…”

International Capital Flow Pressures

“…The international financial flow perspective and international portfolio balance approach follow the long tradition of Girton and Henderson (1976), Henderson and Rogoff (1982), Branson and Henderson (1985), Kouri (1981), Blanchard et al (2005), Coeurdacier and Rey (2013), Caballero, Farhi and Gourinchas (2016), and Gabaix and Maggiori (2015). We assume imperfect substitutability between domestic and foreign currency denominated assets, modeled as home bias for domestic currency denominated assets, following Blanchard et al (2005) and consistent with the empirical evidence on home currency bias in international portfolios by Maggiori, Neiman and Schreger (2019). 10 Demand for net private foreign assets denominated in foreign currency, and net liabilities denominated in domestic currency (and hence foreign currency from the perspective of the foreign creditor) are functions of relative expected returns, expressed as deviations from uncovered interest rate parity (uip t ), risk sentiment pertinent to each country's investment decisions, s t and s * t , and domestic and foreign financial wealth, W t and W * t respectively, both expressed in terms of their local currencies.…”

“…Exchange rates also respond to global financial conditions, with relative appreciations under elevated global risk aversion a feature of so called safe haven currencies (Ranaldo and Soederlind, 2010;Botman, Filho and Lam, 2013;Habib and Stracca, 2012;de Carvalho Filho, 2015;Bundesbank, 2014). The broader literature also considers the currencies that exhibit outflow pressures with elevated risk, and addresses other manifestations of the sensitivity of capital flow pressures to global financial factors such as the failure of uncovered interest rate parity (Du and Schreger, 2016;Maggiori et al, 2019). This sensitivity is key to understanding the degree to which local economies retain some domestic policy autonomy and the relative importance of local and idiosyncratic factors (Miranda-Agrippino and Rey, 2015;Obstfeld, Ostry and Qureshi, 2019;Cerutti, Claessens and Rose, 2019).…”

“…Important parameter decisions pertain to choices on capital flow elasticities, as these are not well pinned down in the literature. Also consequential are treatments of the role of currency denomination in portfolios of foreign assets and liabilities (Benetrix, Lane and Shambaugh, 2015;Maggiori, Neiman and Schreger, 2019). While countries' foreign assets are usually quoted in equivalents of either domestic currency or US dollars, the currency denomination of countries' liabilities is much more diverse.…”

Sovereign finance in emerging markets

“…The change of the currency denomination of liabilities from foreign to local also happened when restricting the scope to debt markets. Such outcome occurred mostly through an increasing participation of non-resident lenders in local government debt markets (Burger, Warnock and Warnock, 2010, Arslanalp and Tsuda, 2014, Alfaro and Kanczuk, 2017, and Maggiori, Neiman and Schreger, 2018 1 .…”