Credit Spread Disparity Between Japanese Domestic Bonds and Foreign Bonds

This article is an empirical study of credit spread disparity between Japanese domestic bonds and foreign bonds on primary issuance. There exist differences between credit spreads issued in domestic market and that of foreign market, despite that the credit risk of these bonds are considered the same. We explore this issue and find that the disparity can be explained by the sensitivity to risk-free rate and leverage. In other words, foreign investors put more premium on the credit risk which is driven by risk-free rate factor and leverage factor.

Exchange Rate Determination: The Portfolio-Balance Approach

The portfolio-balance approach to exchange rate determination is part of the Asset Market Models and is largely attributed to economists after 1973 when the exchange rate became flexible (market determined). This article first introduces the setting of the model embedded in the portfolio balance approach that encompasses two assets (money and bonds), which deviates a little from the models and approaches used for the monetary approach to the balance of payment, the overshooting model, and from the associated market equilibria. The effects of monetary policy, of current account, and of wealth under the portfolio-balance approach are examined, here, theoretically and empirically. The current econometric results show that the exchange rate is determined by the foreign bonds, the domestic interest rate, and the foreign interest rate. JEL classification numbers: F31, F47, E52, E41, C52, E21, E43. Keywords: Foreign Exchange, Forecasting and Simulation, Monetary Policy, Demand for Money, Model Evaluation and Testing, Consumption and Saving, Interest Rates.

Exchange Rate Reconnect

It is surprisingly difficult to find economic variables that strongly co-move with exchange rates, a phenomenon codified in a large literature on “exchange rate disconnect.” We demonstrate that a variety of common proxies for global risk appetite, which did not co-move with exchange rates prior to 2007, have provided significant in-sample explanatory power for currencies since then. Furthermore, during 2007-2012, U.S. purchases of foreign bonds were highly correlated with these risk measures and with exchange rates. Our results support the narrative that the US dollar's role as an international and safe-haven currency has surged since the global financial crisis.

Foreign Affairs

A speculative and unstable credit boom occurred in overseas markets during the 1920s, as universal banks and private investment banks competed aggressively to sell more than $12 billion of foreign bonds to U.S. investors. The resulting surge in overseas lending left many governments and private sector borrowers in Central and Eastern Europe and Latin America in a dangerously exposed position when U.S. investors lost their appetite for foreign bonds at the end of the 1920s. Universal banks and investment banks sold many unsound foreign bonds to unsophisticated and trusting American investors. The massive sales of risky domestic and foreign securities by universal banks and investment banks had highly adverse effects on the U.S. economy, foreign economies, and investors when the domestic and overseas financing booms abruptly ended following the stock market crash in late 1929.

The Term Structure of Currency Carry Trade Risk Premia

Fixing the investment horizon, the returns to currency carry trades decrease as the maturity of the foreign bonds increases. Across developed countries, the local currency term premia, which increase with the maturity of the bonds, offset the currency risk premia. Similarly, in the time-series, the predictability of foreign bond returns in dollars declines with the bonds’ maturities. Leading no-arbitrage models in international finance do not match the downward term structure of currency carry trade risk premia. We derive a simple preference-free condition that no-arbitrage models need to reproduce in the absence of carry trade risk premia on long-term bonds. (JEL E43, G12, G15)

Towards a More Ethical Lending to Sovereigns

This chapter examines the relationship between a private household in one country and the foreign government whose bond the household has purchased. What is the ‘right’ thing for a household to want to do when the government encounters economic difficulties and faces pressure to cut back social spending that was advancing human rights objectives? Individual bondholders are in any case rarely empowered to act on their ethical priorities. The nature of sovereign bond contracts gives ethical savers little room to give vent to their ethical preference. The chapter also specifies the concerns that ethical savers have to face when they have lent to a sovereign government that defaults on its foreign bonds. After specifying the characteristics of the problem, the chapter addresses an actual case in point, which, while not a sovereign case per se, involves the essential characteristics of the sovereign case. It will be argued that the source of the ethical frustration derives from the structure of the bond contract. The suggested solution is to redesign sovereign bond contracts in a more human rights-supportive way.

Exchange Rate Dynamics, Endogenous Risk Premium and the Balance Sheet Effect: An Effective Demand Model

This article describes a macroeconomic framework for analysing the interaction between output, domestic interest rate and exchange rate in the presence of the endogenous risk premium and balance sheet effect of exchange rate depreciation on investment demand. Output is demand determined. There are three assets: money, domestic bonds and foreign bonds. Domestic bonds and foreign bonds are not perfect substitutes due to the presence of risk premium. The endogenous risk premium depends on certain macroeconomic fundamentals, namely budget deficit and current account balance. Using this framework, we will examine implications of monetary policy, fiscal policy, tariff liberalization and global interest rate hike for exchange rate dynamics and output. The balance sheet effect and the risk premium together explain how an expansionary fiscal policy may generate recession, while tariff liberalization may produce favourable macroeconomic outcomes. Moreover, the model shows that an increase in world interest rate may have contractionary effect on the domestic output level due to the presence of the balance sheet effect of exchange rate depreciation. JEL Classification: E27, E63, F13, F32

Foreign Safe Asset Demand for US Treasurys and the Dollar

We present theory showing that the spot dollar exchange rate reflects the value of all future convenience yields that foreign investors assign to US Treasuries. The convenience yield also creates wedge, the Treasury-based dollar basis, between the yield on foreign bonds and the currency-hedged yield on US Treasury bonds. We use the Treasury basis to measure the foreign convenience yield and show that an increase in the basis coincides with an appreciation of the dollar, consistent with the theory. The variation in the Treasury basis accounts for 25 percent of the quarterly variation in the dollar between 1988 and 2017.