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Welcome to the Homepage of International Finance 501 at Cambridge University.
This page is updated before and after each lecture: please check it weekly.
Lectures:
Giancarlo Corsetti office hours:
Useful study guide
Outline
The course is taught by Giancarlo Corsetti. It consists of 2 parts.
Part I: INTERNATIONAL FINANCE (G. Corsetti)
Review of asset pricing. The foreign exchange market. Arbitrage and equilibrium pricing in international financial markets: covered and uncovered interest parity (CIP and UIP), theory and evidence. Effects of capital controls. Anomalies after the global crisis. Carry trade and currency speculation: evidence on extra return. The peso problem. Exchange rate determination. Monetary policy and exchange rates.
Part II: RISK AND THE MACROECONOMY (G. Corsetti)
Functions of international financial market: risk sharing, efficient allocation of resources. Sovereign risk, moral hazard and liquidity risk. Topics include current account and global imbalances, asset trade and diversification, debt crises and bailouts, debt redemption.
Readings
Unfortunately, there is no good reference book for this course. This is a reason why lecture notes are long and reasonably detailed. After each lecture, you will have a few suggested readings. Starred readings are required (**) (*). Non-starred reading are more demanding and linked to possible research projects. As general reference books, we will sometimes be using:
Obstfeld M and K Rogoff (OR) Foundations of International Macroeconomics, MIT press, 1996
Lyons R. The microstructure approach to exchange rates, MIT 2001
Stephanie Schmitt-Grohe, Martin Uribe and Michael Woodford (SUW) International Macroeconomics.
Alain Chaboud masterclass in Cambridge Foreign exchange market
Lecture notes and main readings
PART I
Lecture notes Cash flows, discount, asset pricing and portfolios: a brief review of basics
Overview: Basic asset pricing; cash flows, stochastic discount factor, beliefs about distribution. The relation between excess returns and risk. Discounting nominal and real cash flows; in domestic and foreign currency. Portfolios and return. Arbitrage portfolios. Arbitrage opportunities.
An overview of the foreign exchange market. Spot and forward exchange rate, the forward premium. Forex swaps. Arbitrage and covered interest parity (CIP).
Practice questions
Readings:
For the first lecture, there are no starred readings. You are required to familiarise yourselves with the notation and concept in the lecture notes, and read the notes by A. Chaboud to get a sense of the current state of the foreign exchange market.
Alain Chaboud masterclass in Cambridge Foreign exchange market
Referred to in class:
BIS: Triennial Central Bank Survey offoreign exchange and OTC derivatives markets in 2016
Cables, sharks, and the geography of the foreign exchange market, by Barry Eichengreen, Arnaud Mehl, Romain Lafarguette, voxeu.org
Lecture notes 2 Covered Interest Parity (CIP)
Definitions of CIP. Capital controls and market segmentation. The removal of outward and inward capital controls, and their consequences for the CIP: evidence from the 1970s. Political risk.
What explains deviations from CIP: credit risk, counterparty risk in forward markets; borrowing constraint; mis-measurement with high cost of capital for financial intermediaries; convenience yield.
The puzzling failure of the CIP after the outburst of the Global Financial Crisis. Currency basis: definition and discussion. Stylised facts. Competing explanations. Banks balance sheets and the dollar 'cycle': a first look.
Data
CIP dataset Wenxin Du, Joanne Im, and Jesse Schreger
Readings:
Bye-bye covered interest parity Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko, Voxeu.org, 28 September 2016
*** Deviations from Covered Interest Rate Parity, Wenxin Du, Alexander Tepper and Adrien Verdelhan, September 2016.
The Chinn-Ito index of Financial liberalisation:
"Note on the Chinn-Ito Financial Openness Index" includes details on the index.
M. Chinn and I. Hito (2008) "A New Measure of Financial Openness" Journal of Comparative Policy Analysis 10(3): 307-320. Data: Chinn-Ito (2006) Financial Openness measure (data extending to 2008, updated July 2010) Notes to Chinn-Ito Financial Openness measure (7/28/10).
To know more:
Patrick McGuire and Goetz von Peter The US dollar shortage in global banking and the international policy response, BIS Working Paper 291 October
Takeshi Kimura, Teppei Nagano, Exorbitant privilege and the Triffin dilemma through FX swaps, Voxeu.org 30 May 2017
Lecture notes 3 Uncovered interest parity
Contrast covered and uncovered interest parity --- arbitrage vs equilibrium conditions. Deriving the UIP condition: the role of inflation variability and risk. Derivation of UIP tests based on rational expectations: the Fama regression. The UIP puzzle: two empirical dimensions. The UIP puzzle in the aftermath of financial crises. The Fama 84 result.
Readings:
OR Section 8.7 pp. 585-591
Chinn M. and S. Quayyum S. "Long horizon uncovered interest parity re-assessed," 2012 NBER Working Paper 18482
Slides: Revisiting the Fama Puzzle:An Unexpected Journey, Matthieu Bussière, Menzie Chinn* Laurent Ferrara, Jonas Heipertz
To know more:
Chaboud A.P. and J. Wright "Uncovered interest parity: it works, but not for long" Journal of International Economics, 2005, 66(2) 349-362
M.Chinn "The (Partial) Rehabilitation of Interest Rate Parity in the Floating Rate Era: Longer Horizons, Alternative Expectations, and Emerging Markets," JIMF26 (2006): 7-21.
Rosen Valchev Exchange Rates and UIP Violations at Shortand Long Horizons
Lecture notes 4 The returns to Currency Speculation
Carry trade strategies: diversified, hedge, un-hedged. Returns net of transaction costs. Relative performance: Carry Trade versus Equities. Distribution of returns: asymmetries and fat tails. Evidence from emerging markets and after the Global Crisis.
Readings:
A simple and short paper by Hanno Lustig and Adrien Verdelhan on Carry trade as a trading and investment strategy.
Lukas Menkhoff, Lucio Sarno, Maik Schmeling, Andreas Schrimpf, The risk in carry trades, www.voxeu.org, 23 March 2011
Burnside Craig, Martin Eichenbaum, Isaac Kleshchelski and Sergio Rebelo, "Do Peso Problems Explain the Returns to the Carry Trade?" . Review of Financial Studies 24(3), 2011, 853-91.
Lecture notes 5: What explains excess returns to currency speculation?
Risk-based explanations. The Mehra Prescott puzzle. The peso problem (disaster risk).
Readings:
** Mehra Prescott Puzzle: OR page 310-315
More readings:
Burnside C, M Eichenbaum, and S Rebelo, Carry Trade and Momentum in Currency Markets. Annual Review of Financial Economics 3, 511-35.
Menkhoff L, L Sarno, M Schmeling and A Schrimpf "Carry Trades and Global Foreign Exchange Volatility" Journal of Finance, 2012 67(2) 681--718
Carry trade in a monetary union: Viral Acharya, Sascha Steffen, The banking crisis as a giant carry trade gone wrong, voxeu.org, 23 May 2013
Lecture notes 6: Exchange rate determination and forecast
Equilibrium exchange rate: a four-way decomposition. Purchasing Power Parity. Stationarity of the real exchange rate. Adjustment: speed and modalities. Interest rates and exchange rates. The effect of monetary policy. Dynamics of excess returns: Engel 2016. Meese and Rogoff.
Readings:
Ca’ Zorzi, Michele and Emile A. Marin 2018, “Exchange rate premia in imperfect financial markets”, mimeo University of Cambridge
Ca’ Zorzi, Michele, Jakub Muck and Michal Rubaszek, 2016. ”Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses,” Open Economies 27(3), 585-609.
Eichenbaum Martin, Ben Johansen and Sergio Rebelo (2017) “Monetary Policy and the Predictability of Nominal Exchange Rates” mimeo
Charles Engel, 2016. ”Exchange Rates, Interest Rates, and the Risk Premium,” American Economic Review, 106(2):436-474. but read NBER Working Paper No. 21042 March 2015
Mussa, Michael 1986, “Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications,” Carnegie-Rochester Conference Series on Public Policy, Journal of Monetary Economics, (25): 117-214.
** C. Engel and K. West “Global Interest Rates, Currency Returns, and the Real Value of the Dollar,” American Economic Review, Papers and Proceedings 100, May 2010, 562-567.
Menkhoff Sarno Schmling and Schrimpf Currency Value∗ December 2015
Gopinath, Gita. Forthcoming. “The International Price System.” Jackson Hole Symposium Proceedings. NBER Digest, January 2016
Guy Meredith and Menzie Chinn Long-Horizon Uncovered Interest Rate Parity NBER w6797
L Dedola G Rivolta L Stracca If the Fed sneezes, who catches a cold? 2015
A fun piece in economic policy telling the story of the Meese and Rogoff puzzle, by Ken Rogoff on The failure of empirical exchange rate models
On exchange rate and prices: a good general reading is chapter 9 of SUW Manuscript
Advanced Readings
C. Engel “The Real Exchange Rate, Real Interest Rates, and the Risk Premium”, 2011
PART II
Lecture notes 7: Risk Sharing and Consumption Smoothing via asset trade in international financial markets
Complete markets and perfect risk sharing: implications for the stochastic discount factor. Non traded risk with incomplete market. Gains from trade and law of comparative advantages in international finance: which country exports assets on average. Determinants of the current account. First and second order stochastic dominance.
** OR chapter 5 page 269-285 (5.1, 5.2.3)
Lars Svensson, "Trade in Risky Assets", AER 1988.
OR 1.1 (1.2 and 1.3.4.).
Advanced readings:
Chapter 4 of the IMF World Economic Outlook from October 2014: Are Global Imbalances at a Turning Point?
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Niepmann Friederike, "Banking across Borders", Federal Reserve Bank of New York Staff Reports, 576, October 2012, Forthcoming Journal of International Economics
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Lecture notes 8: Sovereign risk
Diversification of risk via equity market. Endogenously incomplete market: strategic default.
moral hazard in international lending is not examinable
** OR 6.1 (up to page 369 and 6.1.2.4) 6.2.4-6.2.5, 6.4
Readings:
Ugo Panizza, Federico Sturzenegger and Jeromin Zettelmeyer, "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, Vol. 47, No. 3, Sep., 2009
Ugo Panizza, Federico Sturzenegger and Jeromin Zettelmeyer, "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, Vol. 47, No. 3, Sep., 2009
Juan Carlos Hatchondo and Leonardo Martinez, The Politics of Sovereign Defaults, Federal Reserve of Bank of Richmond, Economic Quarterly—Volume 96, Number 3—Third Quarter 2010—Pages 291–317
Lecture notes 9: Topics in sovereign risk
Self-fulfilling debt crises, Dealing with SF crises.
Self-interested solidarity is not examinable.
The Mystery of the Printing Press: Monetary Policy and Self-fulfilling Debt Crisis with Luca Dedola, Journal of European Economic Association, December 2016
The text of the Schumpeter Lecture on the Mystery of the Printing Press at the EEA, Mannheim, August 24, 2015 (slides)
Tirole Jean, Country Solidarity in Sovereign Crises. American Economic Review, 2015
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