OUTLINE

This is a lecture series focused on the consequences of financial globalization for asset pricing, risk sharing and financial stability. The series consists of 3 parts:

I. Arbitrage and asset pricing in international markets.

II. Capital market integration and risk sharing.

III. Sovereign risk, debt/currency crises, official lending.

Technical (algebra) requirement will be kept at a minimum, and explained in a self-contained way during lectures. We will build up some skills in manipulating asset pricing and international macro models.

Readings: There is no 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 advanced reference books, you can refer to: Obstfeld M and K Rogoff (referred to as OR) Foundations of International Macroeconomics, MIT press, 1996

PART I

Lecture notes Foreign Exchange Market: an Introduction

Readings: Alain Chaboud masterclass in Cambridge Foreign exchange market

To know more:

BIS: Triennial Central Bank Survey of foreign exchange and OTC derivatives markets 2019

Foreign Exchange Working Group and the FX global code

A useful glossary of terms related to payment, clearing and settlement systems by the European Central Bank

The rise of the dollar and fall of the euro in global asset trade, Matteo Maggiori, Brent Neiman, Jesse Schreger Voxeu.org 18 June 2018

Lecture notes 1 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. Practice questions

Lecture notes 2 Deregulation and liberalisation of capital markets

Capital controls and market segmentation. The Chinn-Ito index of Financial liberalisation. The removal of outward and inward capital controls, and their consequences for the CIP: evidence from the 1970s. Political risk.

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).

Lecture notes 3 Covered Interest Parity (CIP)

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. What can explain deviations from CIP: credit risk, counterparty risk in forward markets; borrowing constraint; high cost of capital for financial intermediaries; convenience yield.

Readings:

Bye-bye covered interest parity Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko, Voxeu.org, 28 September 2016

Borio, C, R McCauley, P McGuire and V Sushko (2016), “Covered interest parity lost: understanding the cross-currency basis”, BIS Quarterly Review, September, pp 45–64.

Global Financial Stability Notes: The Strains in Offshore US Dollar Funding during the COVID-19 Crisis: Some Observations, Prepared by: Adolfo Barajas, Andrea Deghi, Salih Fendoglu, and Yizhi Xu, Monetary and Capital Markets. IMF July 2020

US dollar funding markets during the Covid-19 crisis-the international dimension. Egemen Eren, Andreas Schrimpf and Vladyslav Sushko, BIS Bulletin no. 15, 12 May 2020

Advanced readings:

Deviations from Covered Interest Rate Parity, Wenxin Du, Alexander Tepper and Adrien Verdelhan, September 2016.

Data: CIP dataset Wenxin Du, Joanne Im, and Jesse Schreger

Lecture notes 4 Uncovered Interest Parity

Deriving the UIP condition: the role of inflation variability and risk. Derivation of UIP tests based on rational expectations: the Fama regression. The traditional and the new Fama puzzle. A reformulation of the puzzle.

Readings: OR book. Section 8.7 pp. 585-591

Chinn M. and S. Quayyum S. "Long horizon uncovered interest parity re-assessed," 2013 Working Paper 18482

The new Fama puzzle, 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

Rosen Valchev Exchange Rates and UIP Violations at Short and Long Horizons, No 1446, 2015 Meeting Papers from Society for Economic Dynamics

Lecture notes 5 The Returns to Currency Speculation

Carry trade strategies: diversified, hedge, and unhedged. 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:

Hanno Lustig and Adrien Verdelhan: Carry trade as a trading and investment strategy.

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.

Lukas Menkhoff, Lucio Sarno, Maik Schmeling, Andreas Schrimpf, The risk in carry trades, www.voxeu.org, 23 March 2011

Lecture notes 6 What Explains Excess Returns to Currency Speculation?

The Fama 84 result. CAPM-based explanations. The peso problem (disaster risk). Time varying disaster risk.

Readings: Mehra-Prescott Puzzle: OR page 310-315

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.

An update of the study: Burnside Craig, Exchange Rates, Interest Parity, and the Carry Trade. Oxford Research Encyclopedia of Economics and Finance, 2019. Older version here.

To know more:

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

Lecture notes 7 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:

Eichenbaum Martin, Ben Johansen and Sergio Rebelo (2017) “Monetary Policy and the Predictability of Nominal Exchange Rates” mimeo. See references in the notes

Lecture notes 8 Taking stock

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

A century of arbitrage and disaster risk pricing in the foreign exchange market, with Emile Marin, March 2020

PART II

Lecture notes 9

International Risk Sharing and Consumption Smoothing

Complete markets and perfect risk sharing. Non traded risk. 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. Global Imbalances.

** 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.).

Lecture notes 10

Testing for International Risk Sharing

PART III

Lecture notes 11

The problem of sovereign (and country) risk

Endogenously incomplete market: strategic default.

** OR 6.1 (up to page 369 and 6.1.2.4) 6.2.4-6.2.5.

To know more:

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—pp 291–317

Lecture notes 12

Debt crises

Debt Crises: Fundamental vs. Self-Fulfilling

Debt Sustainability Analysis: State of the Art Study requested by the ECON Committee of the European Parliament, Economic Governance Support Unit Directorate-General for Internal Policies of the Union - November 2018 Direct access to text

FCaffe' lectures (preliminary)

Lecture 1

Lecture 2

Lecture notes 13

Addressing debt crises and On Official Lending

Backstops, bailouts and forgiveness

Tirole Jean, Country Solidarity in Sovereign Crises. American Economic Review, 2015

Official Lending and debt sustainability in the euro area, Giancarlo Corsetti, Aitor Erce, Timothy Uy, 13 February 2019

To know more:

Official Lending Strategies During the Euro Area Crisis, Giancarlo Corsetti Aitor Erce and Timothy Uy, CEPR DP 12228, September 2017, Download the dataset

The Mystery of the Printing Press: Monetary Policy and Self-fulfilling Debt Crisis with Luca Dedola. Journal of European Economic Association. Here is the text of my Schumpeter Lecture on the Mystery of the Printing Press at the EEA, Mannheim, August 24, 2015 (slides)

Addendum

Federico Caffe' Lecture 2019

Lecture 1

Lecture 2

Lecture notes 14

Currency Crises

To know more:

Giancarlo Corsetti and Bartosz Mackowiak, Fiscal Imbalances and the Dynamics of Currency Crises. European Economic Review 2006