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Beyond Bilateral Flows: Indirect Connections and Exchange Rates

Author

Listed:
  • Bahaj, Saleem
  • Della Corte, Pasquale
  • Massacci, Daniele
  • Seyde, Eduard

Abstract

This paper studies how cross-border financial connections affect the response of exchange rates to trade shocks. Theoretically, we develop a multi-country model whereby a country's exchange rate depends on the financiers' ability to manage capital flows between this country and its counterparties (direct connection) and between its counterparties and their trading partners (indirect connection). Empirically, we quantify the network of financial connections using granular data on cross-border claims and liabilities of globally active banks. Consistent with our theoretical predictions, we find that indirect connection can either amplify or mitigate the impact of trade shocks on future exchange rate returns, depending on the shock's origin and size, while direct connection always dampens these effects.

Suggested Citation

  • Bahaj, Saleem & Della Corte, Pasquale & Massacci, Daniele & Seyde, Eduard, 2024. "Beyond Bilateral Flows: Indirect Connections and Exchange Rates," CEPR Discussion Papers 19310, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:19310
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    More about this item

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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