Theses Doctoral

Essays in international finance and central bank policy

Tessari, Cristina

This dissertation studies topics in international finance and central bank policy. In the first chapter, "Common idiosyncratic volatility and carry trade returns", I provide new evidence that incomplete consumption risk sharing across countries is an important determinant of carry trade returns. I show that there is a strong co-movement in idiosyncratic volatilities over time, and that shocks to the common idiosyncratic volatility (CIV) factor, defined as the equally weighted average of the idiosyncratic volatilities in the cross-section, are priced. I find that high-interest rate currencies deliver low returns when the CIV increases, which are bad times for investors. Low-interest rate currencies provide a hedge by yielding positive returns. CIV shocks remain an empirically powerful risk factor in explaining the cross-section of carry trade returns after controlling for global foreign exchange (FX) volatility risk. Furthermore, CIV risk is correlated with cross-country income risk faced by households. My findings are consistent with a heterogeneous-agent model with persistent, uninsurable idiosyncratic shocks in consumption growth. The calibrated model quantitatively accounts for the cross-sectional differences in average returns across CIV-beta sorted portfolios for plausible market prices of CIV risk.

In the second chapter, "Fed-implied market conditions", we propose a novel text processing technique to extract views of market conditions that are implicit in the Fed's policy statements and minutes. The method is easy to apply and addresses several problems inherent in the use of changes in interest rates as a proxy for central bank policy. First, we project market variables into the text of FOMC statements and minutes (separately) using support vector regressions (SVRs) to predict the levels of 10-year yields, 3-month yields, 2s10s, DXY index, VIX, high-yield (HY) and investment-grade (IG) spreads. We then define measures of monetary policy (``FDIF'' variables) as the Fed-implied deviation away from the market variable: the out-of-sample value of the market variable implied by the SVR minus the corresponding value of the market variable the day before the statement (minutes) release. We show that different markets respond differently to monetary policy news in the short-run, in a way that has independent and complementary implications for market movements in the long-run. Fed news also has important long-run implications for macroeconomic outcomes. Our Fed measures outperform Bernanke-Kuttner and changes in 2-year yields for forecasting macro and financial outcomes in the future. Finally, we show that there are Fed-risky and Fed-hedging industries, and these earn risk premia on Fed statement days.

Finally, in the third chapter, "Does the counterparty of central banks in derivatives-based foreign exchange interventions matter?", we study how the central bank counterparty in foreign exchange interventions affect the supply of hedge against FX risks to the private sector. We use Brazilian data where derivatives-based interventions have been used in tandem for almost two decades. The analysis finds evidence of a link between central bank counterparties in FX swap operations and the supply of hedge through FX futures contracts. The main central bank counterparty in foreign exchange interventions uses the liquidity provided by the central bank to increase the supply of hedge to the private sector. Other counterparties use the US dollars provided by the central bank to reduce their own foreign exchange exposure.


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More About This Work

Academic Units
Thesis Advisors
Van Nieuwerburgh, Stijn G.
Mamaysky, Harry
Ph.D., Columbia University
Published Here
April 20, 2021