Dealer Risk Limits and Currency Returns

Empirical validation of the theory that financial frictions such as financial institutions’ risk-bearing constraints can affect exchange rate dynamics has eluded researchers in part because it is difficult to observe the constraints of the specific actors. The fact that risk-bearing constraints are...

Full description

Saved in:
Bibliographic Details
Published in:Policy File 2024
Main Authors: Barbiero, Omar, Bräuning, Falk, Gustavo Joaquim, Stein, Hillary
Format: Report
Language:English
Subjects:
Banking
Currency
Finance
Risk assessment
Online Access:Request full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:Empirical validation of the theory that financial frictions such as financial institutions’ risk-bearing constraints can affect exchange rate dynamics has eluded researchers in part because it is difficult to observe the constraints of the specific actors. The fact that risk-bearing constraints are endogenous to the broader market conditions that may govern exchange rates further hinders validation. This paper provides empirical support for the role of financial intermediaries in driving exchange rate dynamics by focusing on the constraints of global banks’ currency trading desks. The authors use a novel supervisory data set on risk limits at the trading-desk level to show that movements in market-maker constraints do in fact affect exchange rates when there is a currency flow to be mediated.