ESSAYS ON ASSET PRICING AND MONETARY POLICY
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Abstract
US monetary policy has large impact on global financial market, especially asset prices. My dissertationstudies the transmission of US monetary policy shocks to the international financial market through the lens of financial intermediaries. It consists of three chapters that show that global financial institutions play the crucial role for the pass-through of US monetary policy shocks in the international setting. In Chapter 1 (joint with Mengbo Zhang), we investigates the transmission mechanism of US (un)conventional monetary policy shocks to exchange rates through the lens of global investors’ portfolio rebalancing. The empirical findings show that a tightening US (un)conventional monetary surprise is associated with lower domestic asset prices, net portfolio inflows to the US, and appreciation of the dollar. To quantitatively examine this mechanism, we develop a two-country New Keynesian dynamic stochastic general equilibrium (DSGE) model with financially constrained banks and foreign exchange (FX) dealers. The main insight is that a tightening (un)conventional monetary shock raises the expected returns of domestic assets and induces portfolio inflows to home country as a result of global investors’ substitution towards domestic assets. FX dealers intermediate the associated imbalances subject to limited risk-bearing capacity, which leads to appreciation of the home currency. The banks’ binding financial constraints amplify the pass-through of conventional monetary policy shocks and make the central bank’s quantitative easing (QE) effective in the model. Importantly, domestic monetary policy generates large asymmetric effects on financial market and real economy in two countries due to banks’ binding financial constraints and home bias of assets holding. Our model can also explain several empirical puzzles on currency premia andbond term premia. We discipline our quantitative model by targeting estimates from a structural vector autoregression (SVAR). Our quantitative analysis indicates that FX dealers’ limited liquidity intermediation plays a crucial role for the effectiveness of QE in an open economy. In Chapter 2, I identify the long-run risks (LRR) in the frequency domain, and further estimate the macro (consumption) risk premia in different frequency ranges. To achieve the identification, I employ the long-run projections and the associated inference procedure for I(0) process developed in Müller and Watson (2018, 2020). Build in their low-frequency regression framework in time series, I further propose a Bayesian implementation of two-pass regression to estimate the consumption risk premia in different frequency bands. I then perform the method on the US data across different asset classes. My empirical findings show that there is a low- frequency component (LRR) in consumption, which drives the long-run comovement of its with different financial variables. Importantly, the identified relevant cycles of LRR span around from 3 to 35 years. The resulting estimates are close to the choices of calibration parameters or estimated parameters based on other methods in the existing literature. My empirical results show that the low-frequency variations in consumption growth are not significantly priced in equity market, which is consistent with the implication of LRR models. In Chapter 3 (joint with Nikolai Roussanov), we document that U.S. dollar exchange rate are predictable by U.S. bond yields in the weeks around monetary policy announcements, rising following an increase in yields. In the post zero- lower-bound period, the information in the “path” factor that reflects forward guidance surprises is impounded in the exchange rate over five days following the FOMC meeting. Using data on currency order flows, we trace out the channel for the delayed adjustment of exchange rates to monetary news. Foreign exchange dealers increase dollar purchases immediately following a monetary tightening, while funds and non-bank financial institutions do so with a 3-5 day delay and banks serve as liquidity providers. These flows explain much of the exchange rate predictability that we document. Decomposing the daily change of exchange rate into news about future interest rate differentials, excess returns, and inflation, we find that a surprise future tightening of U.S. monetary policy raises all components: expected future returns, interest rate differentials, and long-run differential between U.S. and foreign inflation.
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Schorfheide, Frank