Browsing by Subject "financial markets"

The broad US dollar index has emerged as a global risk factor since the global financial crisis (GFC). When the spot dollar exchange rate appreciates strongly against a broad basket of currencies, there is a substantial decline in global dollar credit and a tightening of global financial conditions. This relationship reflects several macroeconomic and financial forces, of which mostly global factors related to international finance are considered. In particular, this thesis examines how the relationship is associated with risk appetite, leverage, and balance sheet capacity of global banks to intermediate cross-border capital flows. In addition, the underlying causes are considered through the global role of the dollar as the dominant currency for the international monetary and financial system. The empirical framework examines the dynamic relationship between the dollar, aggregate dollar-denominated cross-border bank flows, and various measures of balance sheet capacity of financial intermediaries. The mechanism follows Bruno and Shin (2015a, b) and the risk-taking channel of exchange rate fluctuations, where a dollar appreciation leads to a decline in the supply of dollar funding through reduced risk-taking capacity of global banks in the presence of currency mismatches. In addition, the framework is evaluated using a measure of global safe asset demand for dollar assets. Both vector autoregressions (VARs) and local projections (LPs) are used for structural analysis. The results support the mechanism in terms of economic and statistical significance, which are pronounced when the 30-year Treasury-swap spread is used as the measure of global intermediary capacity and also hold for the post-GFC sample. The benchmark model suggests that a positive unit shock in the widening of the swap spread immediately leads to a 0.8% increase in the growth of dollar-denominated cross-border bank flows and an equivalent contemporaneous depreciation of the dollar. The short-term effects of a swap spread shock last over three quarters. In turn, a broad dollar appreciation shock causes a narrowing of the 30-year Treasury-swap spread and a decline in the short-term growth of dollar-denominated cross-border bank flows. A positive shock to global demand for safe assets denominated in dollars is associated with a simultaneous 0.6% appreciation of the dollar. While the empirical evidence in this thesis does not establish a strong causal link between exchange rate movements, capital flows, and intermediary constraints, the results are consistent with similar work in the literature. Especially, the relationship between the 30-year Treasury-swap spread, bank leverage, and the dollar is consistent with studies that examine in more detail the co-movement between binding leverage constraints on global banks, higher costs of global dollar funding, and the strength of the dollar. The emergence of the post-GFC relationship and sustained appreciation of the dollar are typically found to be related to US monetary policy, increased role of the dollar as an international currency, greater demand for dollar assets, and reduced financial intermediation capacity in the dollar funding markets.