Working Paper: CEPR ID: DP13182
Authors: Semyon Malamud; Andreas Schrimpf
Abstract: We develop a general equilibrium model with intermediaries at the heart of international financial markets. In our model, intermediaries bargain with their customers and extract rents for providing access to foreign claims. The behavior of intermediaries, by tilting state prices, generates an explicit, non-linear risk structure in exchange rates. We show how this endogenous risk structure helps explain a number of anomalies in foreign exchange and international capital markets, including the safe haven properties of exchange rates and the breakdown of covered interest parity.
Keywords: financial intermediation; exchange rates; safe haven; covered interest parity deviations
JEL Codes: E44; E52; F31; F33; G13; G15; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| intermediary behavior (D16) | exchange rate dynamics (F31) |
| intermediaries extract rents (D40) | state prices (P22) |
| state prices (P22) | nonlinear risk structure in exchange rates (F31) |
| nonlinear risk structure in exchange rates (F31) | anomalies in FX markets (F31) |
| intermediaries’ market power (D40) | intermediation markups (D40) |
| intermediation markups (D40) | risk sharing (D16) |
| intermediation markups (D40) | asset pricing (G19) |
| intermediary behavior (D16) | financial market outcomes (G19) |