Working Paper: CEPR ID: DP14437
Authors: Tobias Adrian; Peichu Xie
Abstract: The USD asset share of non-U.S. banks captures the relative demand for USD denominated assets by these investors. An instrumental variable strategy identifies a causal link from the USD asset share to the USD exchange rate. Furthermore, cross-sectional asset pricing tests show that the USD asset share is a highly significant pricing factor for carry trade strategies. The USD asset share also forecasts the movement of foreign currency against U.S. dollar with economically large magnitude, high statistical significance, and large explanatory power, both in sample and out of sample, pointing towards time varying risk premia. It takes 2-5 years for exchange rate risk premia to normalize in response to demand shocks.
Keywords: Exchange Rate Disconnect; Safe Asset Demand; Intermediary Asset Pricing
JEL Codes: F3; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| USD asset share of non-US banks (F65) | exchange rate of foreign currencies against the USD (F31) |
| increase in treasury premium (H63) | demand for USD assets (E41) |
| higher sovereign risk (F34) | demand for USD assets (E41) |
| leverage of non-US banks (F65) | demand for USD-denominated assets (E41) |
| USD asset share of non-US banks (F65) | contemporaneous changes in the exchange rate (F31) |
| positive shocks to USD asset share (F31) | contemporaneous depreciation of foreign currencies against the USD (F31) |
| demand for USD assets (E41) | immediate currency appreciation (F31) |
| immediate currency appreciation (F31) | subsequent reversion over time (C41) |