Research

Abstract: This paper uncovers the surprisingly substantial foreign exchange risks US firms face under the dominant currency paradigm, from risk spillovers across the production network and demand fluctuations when the exchange rate changes. Using new hand-collected data from firms' annual reports, we document that US firms actively hedge foreign exchange risks using financial derivatives. We develop the first model of hedging in a production network to show that hedging by upstream or downstream firms can stabilize firms' performance due to similar risk exposures. This hedging positive spillover effect works through the firms' financial constraints. Namely, hedging reallocates resources from good to bad states, stabilizing firms' borrowing costs and the prices they charge connected firms. Therefore, through the purchase-sales relationships, firms' hedging influences the performance of connected firms. We use the two major swings in USD-Euro exchange rates to trace out this hedging spillover effect. Consistent with our model, we find that hedging from connected firms is as effective as firms' own hedging to stabilize the firms' performance. Further, when connected firms hedge more, firms hedge less.

Abstract: This paper investigates the impact of reserve tiering, which remunerates different reserve tiers at varying rates, on monetary policy transmission to the loan market. Data from Japan reveals a significant increase in low-interest-rate loans and a decline in medium-interest-rate loans. The analysis indicates that financial institutions’ diverse interest rate exposures to the tiered system drive these changes. Larger, more liquid, and less leveraged banks with lower deposit ratios hold a higher proportion of negative interest rate reserves, while non-depository institutions face de facto negative rates. This enables small banks to secure cheaper funding from non-depository institutions and larger banks through interbank trading, leading to lower-rate loans. Consequently, the loan market becomes riskier as small banks with lower negative rate ratios reduce loan rates, while larger banks with higher negative rate ratios engage in riskier lending practices. Using a heterogeneous agent model to link interbank and loan markets, the study decomposes reserve tiering transmission into liquidity, interest rate, bank interest margin, and loan risk channels, offering policy recommendations for effective transmission. The paper suggests that to cool an overheating economy, the central bank should implement reserve tiering with ascending interest rates, which proves more effective, less costly, and stabilizes the financial system compared to alternatives.

• Abstract: This paper provides the first empirical evidence on how media-driven narratives influence cross-border institutional investment flows into China. Using natural language processing methods and full text from over a million articles published in 38 newspapers, we create media narratives-based sentiment and risk indices for China for a sample of 15 economies over the period 2007-2022. We find that media narratives have a significant impact on portfolio flows, even after accounting for macroeconomic and financial fundamentals. The influence of media narratives is particularly pronounced when reliable market data is scarce or difficult to interpret, with political and environmental narratives exerting a stronger impact than economic ones. Furthermore, the effect of these narratives is smaller for investors with greater familiarity or private information about China and is higher in periods of heightened uncertainty. These results suggest that media narratives affect investment flows through an information intermediation channel. The results highlight the broader implications of media-driven narratives in shaping global capital flows in an era of heightened geopolitical and economic uncertainty.

• Abstract: This paper studies monetary policy transmission in European countries with a significant share of lending and deposits in foreign currency, referred to as ‘euroized economies’. We find that the impact of monetary policy shocks on both inflation and GDP diminishes with the degree of euroization across countries: the effects are twice as high in non-euroized countries compared to countries in our sample with the highest level of euroization. We further examine the exchange rate, credit and interest rate transmission channels which are typically less effective in euroized economies. We show that monetary policy has at best limited effects on the exchange rate. In addition, during the post-pandemic monetary tightening episodes, an increase in foreign-currency loans often softened the decline in overall credit growth, and rates of foreign-currency loans have followed the ECB policy rate rather than the domestic ones. By contrast, our analysis suggests that the pass-through to interest rates of domestic currency loans is similar across countries with different levels of euroization. 

• Abstract: In 2002, China introduced the Qualified Foreign Institutional Investor (QFII) program, allowing foreign institutional investors to trade RMB-dominated "A-shares." This study examines the micro-level impact of this equity market liberalization event. Using novel firm-level investment data, the analysis reveals that QFII promotes capital investment. Surprisingly, however, the study also reveals significant and enduring decreases in stock prices and earnings per share of firms that receive QFII investment compared to those that do not. Two channels contribute to this puzzling outcome. Firstly, QFII investment increases firms’ confidence, leading them to invest in research and development (R&D), which harms short-term profits. Secondly, the presence of an agency problem arises from QFII investors being less informed to participate in firm management. As a result, managers invest in riskier projects and misallocate funding, which is observed by the market, leading to the withdrawal of funding and a decline in stock prices.

Abstract: We study the role of the US dollar exchange rate in shaping the US domestic business dynamism through trade and multi-national production. In a heterogeneous firm trade model with a variable exchange rate, we show that a relatively strong dollar increases net imports and induces higher-productivity firms to operate overseas. Both forces expand the output gap between high-and-low productivity firms, contribute to the rise in mark-up and market concentration, as well as hinder firm entry and growth rate in the domestic market. We then fit our model to bilateral trade and price data for the last three decades to evaluate the impact of the dollar on domestic firm dynamics. Our results point to the important role of the dollar exchange rate in the decline of business dynamism in the US.