Research

Abstract: This paper uncovers the substantial foreign exchange risks faced by U.S. firms, despite most international trade being invoiced in U.S. dollars, due to spillovers through the production network and foreign demand fluctuations when exchange rate changes. Using new hand-collected data from firms’ annual reports, we document that U.S. firms actively hedge these 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 a firm’s performance due to shared risk exposures. This hedging positive spillover effect works through firms’ financial constraints. Hedging reallocates resources from good to bad states, stabilizing firms’ borrowing costs and the prices they charge connected firms. Therefore, firms’ hedging influences the performance of connected firms through the purchase-sales relationships. We use two major swings in the USD-Euro exchange rate to trace out this hedging spillover effect, finding that hedging by connected firms is as effective as a firm’s own hedging in stabilizing the firms’ performance. Additionally, firms at the production and trade network’s extremities are more likely to hedge. Our model, calibrated with U.S. data, shows that these positive spillover effects through the borrowing cost channel boost aggregate output and lower prices.

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 offers the first empirical evidence on how domestic media-driven narratives about a destination country shape cross-border institutional investment flows. Leveraging natural language processing techniques on over a million articles from 38 newspapers, we construct sentiment and risk indices based on media narratives about China across 15 economies between 2007 and 2022. Our findings reveal significant cross-country variation in these narratives, driven by differences in both topic coverage and within-topic sentiment. Crucially, media narratives significantly influence portfolio flows, even after controlling for macroeconomic and financial fundamentals. The impact of media narratives on flows is smaller for investors with greater familiarity or private information about China and more substantial during periods of heightened uncertainty. Political and environmental narratives influence investment flows as much as, or more than, economic narratives. These findings suggest that media narratives have a greater influence on investment flows when reliable market data is scarce or challenging to interpret. We also find that media narratives have an asymmetric impact on investment, with investors reacting more sharply to negative narratives than positive ones. These results underscore the important role of media-driven narratives in shaping global capital flows, particularly in an era of intensifying 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: This research investigates the interconnected liquidity dynamics between the US Treasury securities market and the foreign exchange (FX) market, focusing on the effects of market stress events and central bank liquidity policies. Using high-frequency trading data for Treasury securities and the ten most traded currencies against the USD, the study employs an event study methodology to analyze liquidity changes during market stress events and central bank interventions. Preliminary findings indicate a significant pass-through of liquidity shocks from the Treasury market to the FX market, evidenced by declines in currency pair liquidity following Treasury market disruptions. This research underscores the importance of understanding liquidity interactions and provides guidance for policymakers to manage liquidity crises effectively.

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. 

• 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.