Banque Nationale De Belgique Sa · EURONEXT:BNB

Banque Nationale De Belgique Sa — Technical Presentation (December 2024)

74 slides from Banque Nationale De Belgique Sa's technical presentation, Dec 20, 2024

1. Slide 1: Speculation, Forward Exchange Demand, and CIP Deviations in Emerging Economies

   Speculation, Forward Exchange Demand, and CIP Deviations in Emerging Economies Pierre De Leo Lorena Keller Dongchen Zou U of Maryland U Penn Wharton U Penn Wharton 14th Workshop on Exchange Rates National Bank of Belgium | December 20, 2024

2. Slide 2: Covered Interest Parity Deviations in Emerging Economies

   Covered Interest Parity Deviations in Emerging Economies • Covered Interest Parity (CIP) in logs: st : Home Currency per $ rt$ = rt − (ft − st ) 1 / 16

3. Slide 3: Covered Interest Parity Deviations in Emerging Economies

   Covered Interest Parity Deviations in Emerging Economies • Covered Interest Parity (CIP) deviations: St S CIP Deviationt ≡ rt$ − [rt + st − ft ] t Ft Ft 1 / 16

4. Slide 4: Covered Interest Parity Deviations in Emerging Economies

   Covered Interest Parity Deviations in Emerging Economies • Covered Interest Parity (CIP) deviations: St S CIP Deviationt ≡ rt$ − [rt + st − ft ] t Ft Ft • CIP deviations in emerging economies: large, volatile, correlated and heterogeneous 1 / 16

5. Slide 5: Covered Interest Parity Deviations in Emerging Economies

   Covered Interest Parity Deviations in Emerging Economies • Covered Interest Parity (CIP) deviations: St S CIP Deviationt ≡ rt$ − [rt + st − ft ] t Ft Ft • CIP deviations in advanced economies: small, predominantly negative 1 / 16

6. Slide 6: Covered Interest Parity Deviations in Emerging Economies

   Covered Interest Parity Deviations in Emerging Economies • Covered Interest Parity (CIP) deviations: St S CIP Deviationt ≡ rt$ − [rt + st − ft ] t Ft Ft • CIP deviations in emerging economies: large, volatile, correlated and heterogeneous 1 / 16

7. Slide 7: Covered Interest Parity Deviations in Emerging Economies

   Covered Interest Parity Deviations in Emerging Economies • Covered Interest Parity (CIP) deviations: St S CIP Deviationt ≡ rt$ − [rt + st − ft ] t Ft Ft • CIP deviations in emerging economies: large, volatile, correlated and heterogeneous • This paper: currency speculation drives forward demand and

8. Slide 8: Forward Demand and CIP Deviations in Emerging Economies

   Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies 2 / 16

9. Slide 9: Forward Demand and CIP Deviations in Emerging Economies

   Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies (a) Global investors demand forwards, exploit predictable currency returns eg. carry trade 2 / 16

10. Slide 10: Forward Demand and CIP Deviations in Emerging Economies

    Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies (a) Global investors demand forwards, exploit predictable currency returns eg. carry trade (b) Local Intermediaries supply forwards s.t. limits on FX mismatch & balance sheet 2 / 16

11. Slide 11: Forward Demand and CIP Deviations in Emerging Economies

    Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies (a) Global investors demand forwards, exploit predictable currency returns eg. carry trade (b) Local Intermediaries supply forwards s.t. limits on FX mismatch & balance sheet • Evidence: Pe

12. Slide 12: Forward Demand and CIP Deviations in Emerging Economies

    Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies (a) Global investors demand forwards, exploit predictable currency returns eg. carry trade (b) Local Intermediaries supply forwards s.t. limits on FX mismatch & balance sheet • Evidence: Pe

13. Slide 13: Forward Demand and CIP Deviations in Emerging Economies

    Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies (a) Global investors demand forwards, exploit predictable currency returns eg. carry trade (b) Local Intermediaries supply forwards s.t. limits on FX mismatch & balance sheet • Evidence: Pe

14. Slide 14: Forward Demand and CIP Deviations in Emerging Economies

    Forward Demand and CIP Deviations in Emerging Economies • Model: forward exchange market of emerging economies (a) Global investors demand forwards, exploit predictable currency returns eg. carry trade (b) Local Intermediaries supply forwards s.t. limits on FX mismatch & balance sheet • Evidence: Pe

15. Slide 15: Outline

    Outline 1 Forward Market: Participants, Position, and Prices 2 CIP Deviations, UIP Deviations, and Global Risk Factors 3 Remarks on Forward Demand, Segmentation, Convenience Yields

16. Slide 16: Forward Market: Participants

    Forward Market: Participants Forward market Spot market Global investors (domiciled outside of home country) Local Intermediaries (subject to local regulation) 3 / 16

17. Slide 17: Forward Market: Participants

    Forward Market: Participants Forward market Spot market Global investors (domiciled outside of home country) Local Intermediaries (subject to local regulation) • Assumption: Global Investors operate in forwards, not short-term bonds 3 / 16

18. Slide 18: Forward Market: Participants

    Forward Market: Participants Forward market Spot market Global investors (domiciled outside of home country) Local Intermediaries (subject to local regulation) • Assumption: Global Investors operate in forwards, not short-term bonds ex: Peru i. Only local intermediaries can access CB’s primary aucti

19. Slide 19: Forward Demand: Global Investors

    Forward Demand: Global Investors • Return from home-currency-long forward position (1-USD short) ft − st +1 4 / 16

20. Slide 20: Forward Demand: Global Investors

    Forward Demand: Global Investors • Return from home-currency-long forward position (1-USD short) Realized UIP Deviation t CIP Deviation t z }| { z }| { ft − st +1 = [(rt − rt? ) − (st +1 − st )] + [(ft − st ) − (rt − rt? )] 4 / 16

21. Slide 21: Forward Demand: Global Investors

    Forward Demand: Global Investors • Return from home-currency-long forward position (1-USD short) Realized UIP Deviation t CIP Deviation t z }| { z }| { ft − st +1 = [(rt − rt? ) − (st +1 − st )] + [(ft − st ) − (rt − rt? )] • Global investors choose forward position Ht +1 to max mean-variance utilit

22. Slide 22: Forward Demand: Global Investors

    Forward Demand: Global Investors • Return from home-currency-long forward position (1-USD short) Realized UIP Deviation t CIP Deviation t z }| { z }| { ft − st +1 = [(rt − rt? ) − (st +1 − st )] + [(ft − st ) − (rt − rt? )] • Global investors choose forward position Ht +1 to max mean-variance utilit

23. Slide 23: Forward Demand: Global Investors

    Forward Demand: Global Investors • Return from home-currency-long forward position (1-USD short) Realized UIP Deviation t CIP Deviation t z }| { z }| { ft − st +1 = [(rt − rt? ) − (st +1 − st )] + [(ft − st ) − (rt − rt? )] • Global investors choose forward position Ht +1 to max mean-variance utilit

24. Slide 24: Forward Supply: Local Intermediaries

    Forward Supply: Local Intermediaries ? • Local intermediaries hold forward position Kt +1 and bond portfolio (Gj,t +1 , Gj,t +1 ) 5 / 16

25. Slide 25: Forward Supply: Local Intermediaries

    Forward Supply: Local Intermediaries ? • Local intermediaries hold forward position Kt +1 and bond portfolio (Gj,t +1 , Gj,t +1 ) I. Local intermediaries subject to limits on currency mismatches . local holdings 5 / 16

26. Slide 26: Forward Supply: Local Intermediaries

    Forward Supply: Local Intermediaries ? • Local intermediaries hold forward position Kt +1 and bond portfolio (Gj,t +1 , Gj,t +1 ) I. Local intermediaries subject to limits on currency mismatches . local holdings II. Local intermediaries subject to limits on forward positions . max problem 5 / 16

27. Slide 27: Forward Supply: Local Intermediaries

    Forward Supply: Local Intermediaries ? • Local intermediaries hold forward position Kt +1 and bond portfolio (Gj,t +1 , Gj,t +1 ) I. Local intermediaries subject to limits on currency mismatches . local holdings II. Local intermediaries subject to limits on forward positions . max problem • Local in

28. Slide 28: Forward Market Equilibrium

    Forward Market Equilibrium • Forward market clearing − Ht + 1 = K t + 1 CIP Deviationst Supply E CIP \ Devt E Demand −ĤtE+1 = K̂tE+1 Dollar forward 6 / 16

29. Slide 29: Positions and Prices in Forward Market

    Positions and Prices in Forward Market Proposition 1 Local intermediaries’ dollar position in the forward market: (a) is negatively correlated with global investors’ position; (b) is negatively correlated with the CIP deviation; (c) delivers positive profits on their CIP trade. 7 / 16

30. Slide 30: Positions and Prices in Forward Market

    Positions and Prices in Forward Market Proposition 1 Local intermediaries’ dollar position in the forward market: (a) is negatively correlated with global investors’ position; (b) is negatively correlated with the CIP deviation; (c) delivers positive profits on their CIP trade. • Confront with Peru f

31. Slide 31: Local Intermediaries Intermediate Global Forward Demand

    Local Intermediaries Intermediate Global Forward Demand 8 / 16

32. Slide 32: Local Intermediaries' Position Related to CIP Deviations

    Local Intermediaries’ Position Related to CIP Deviations 8 / 16

33. Slide 33: Local Intermediaries Earn CIP profit

    Local Intermediaries Earn CIP profit Profits higher for intermediaries trading more w/ foreigners . across banks . foreigners’ returns 8 / 16

34. Slide 34: Outline

    Outline 1 Forward Market: Participants, Position, and Prices 2 CIP Deviations, UIP Deviations, and Global Risk Factors 3 Remarks on Forward Demand, Segmentation, Convenience Yields

35. Slide 35: Spot Market

    Spot Market Forward market Spot market Global Investors Currency-Spot Traders (domiciled outside of home country) Inelastic Spot Investors Local Intermediaries (subject to local regulation) • Spot demand: Local Intermediaries (Gt +1 , Gt?+1 ) + Inelastic demand (Nt +1 , Nt?+1 ) • Spot supply: Local,

36. Slide 36: Spot Market

    Spot Market UIP Deviationst Supply E UIP \ Devt E Demand N̂t?+,E1 + Ĝt?+,E1 = −B̂t?+,E1 Dollar spot • Spot demand: Local Intermediaries (Gt +1 , Gt?+1 ) + Inelastic demand (Nt +1 , Nt?+1 ) • Spot supply: Local, risk-averse currency-spot traders holding (Bt +1 , Bt?+1 ) tUIP Deviation z }| { ? ? ? ?

37. Slide 37: UIP Deviations and CIP Deviations across Countries

    UIP Deviations and CIP Deviations across Countries Proposition 2 In the steady-state equilibrium, the cross-currency correlation between UIP devi- ations and CIP deviations is negative. 10 / 16

38. Slide 38: UIP Deviations and CIP Deviations across Countries

    UIP Deviations and CIP Deviations across Countries Proposition 2 In the steady-state equilibrium, the cross-currency correlation between UIP devi- ations and CIP deviations is negative. UIP Deviations Supply UIP Devd,E Ed UIP Devc,E Ec Dc Dd −Bc? −Bd? Dollar spot Spot Market (Steady State) 10 / 16

39. Slide 39: UIP Deviations and CIP Deviations across Countries

    UIP Deviations and CIP Deviations across Countries Proposition 2 In the steady-state equilibrium, the cross-currency correlation between UIP devi- ations and CIP deviations is negative. UIP Deviations CIP Deviations Supply Supply UIP Devd,E Ed UIP Devc,E Ec CIP Devc,E Ec CIP Devd,E Ed Dc Dd Dc Dd −B

40. Slide 40: CIP Deviations and Excess Currency Returns

    CIP Deviations and Excess Currency Returns • 2002-2022 | BRL, CLP, CNY, COP, CZK, HUF, IDR, ILS, INR, KRW, MXN, MYR, PEN, PHP, PLN, RUB, THB, TRY, ZAR . Formal Regression . Net External Positions . Advanced Economies 11 / 16

41. Slide 41: CIP Deviations and Interest Differentials

    CIP Deviations and Interest Differentials • 2002-2022 | BRL, CLP, CNY, COP, CZK, HUF, IDR, ILS, INR, KRW, MXN, MYR, PEN, PHP, PLN, RUB, THB, TRY, ZAR . Formal Regression . Net External Positions . Advanced Economies 11 / 16

42. Slide 42: Global Risk Aversion and CIP Deviations

    Global Risk Aversion and CIP Deviations Proposition 3 Consider countries w/ UIP deviations>0. 12 / 16

43. Slide 43: Global Risk Aversion and CIP Deviations

    Global Risk Aversion and CIP Deviations Proposition 3 Consider countries w/ UIP deviations>0. Global financial disruptions (Γ̂t ↑) cause • less home-currency-forward demand by global investors • higher (less negative) CIP deviations and higher UIP deviations • USD appreciation 12 / 16

44. Slide 44: Global Risk Aversion and CIP Deviations

    Global Risk Aversion and CIP Deviations Proposition 3 Consider countries w/ UIP deviations>0. Global financial disruptions (Γ̂t ↑) cause • less home-currency-forward demand by global investors • higher (less negative) CIP deviations and higher UIP deviations • USD appreciation CIP Deviationst Supply

45. Slide 45: Global Risk Aversion and CIP Deviations

    Global Risk Aversion and CIP Deviations Proposition 3 Consider countries w/ UIP deviations>0. Global financial disruptions (Γ̂t ↑) cause • less home-currency-forward demand by global investors • higher (less negative) CIP deviations and higher UIP deviations • USD appreciation CIP Deviationst UIP Dev

46. Slide 46: Global Risk Factors and CIP Deviations

    Global Risk Factors and CIP Deviations • Principal Component Analysis (PCA) of ∆ in 3-m CIP devs of emerging economies • PC1 captures ≈ 90% of common variation in CIP devs across emerging economies 13 / 16

47. Slide 47: Global Risk Factors and CIP Deviations

    Global Risk Factors and CIP Deviations • Principal Component Analysis (PCA) of ∆ in 3-m CIP devs of emerging economies • PC1 captures ≈ 90% of common variation in CIP devs across emerging economies PC1 CIP-AE CIP-EME Dollar VIX VXEEM US Eq. HKM PC1 1.00 CIP-AE -0.25 1.00 CIP-EME 0.91 -0.08 1.00 Doll

48. Slide 48: Global Risk Factors and CIP Deviations

    Global Risk Factors and CIP Deviations • Principal Component Analysis (PCA) of ∆ in 3-m CIP devs of emerging economies • PC1 captures ≈ 90% of common variation in CIP devs across emerging economies PC1 CIP-AE CIP-EME Dollar VIX VXEEM US Eq. HKM PC1 1.00 CIP-AE -0.25 1.00 CIP-EME 0.91 -0.08 1.00 Doll

49. Slide 49: Dollar Index (DXY) Explains CIP Devs & Positions (Peru)

    Dollar Index (DXY) Explains CIP Devs & Positions (Peru) 14 / 16

50. Slide 50: Dollar Index (DXY) Explains CIP Devs & Positions (Peru)

    Dollar Index (DXY) Explains CIP Devs & Positions (Peru) 14 / 16

51. Slide 51: Outline

    Outline 1 Forward Market: Participants, Position, and Prices 2 CIP Deviations, UIP Deviations, and Global Risk Factors 3 Remarks on Forward Demand, Segmentation, Convenience Yields

52. Slide 52: Remarks on Forward Demand, Segmentation, Convenience Yields

    Remarks on Forward Demand, Segmentation, Convenience Yields 1 Forward exchange demand 6≡ Hedging demand 1. Foreigners hold PEN assets, but are often long PEN forward 2. Foreigners’ PEN forward & PEN bond purchases virtually uncorrelated (ρ = −0.03) 3. Evidence that firms’ hedging is limited in EMEs (

53. Slide 53: Remarks on Forward Demand, Segmentation, Convenience Yields

    Remarks on Forward Demand, Segmentation, Convenience Yields 1 Forward exchange demand 6≡ Hedging demand 2 Market segmentation central to explain emerging vs. advanced economies Proposition 4 If global investor can freely trade in both bond/spot and forward markets, equilibrium CIP deviations are zer

54. Slide 54: Remarks on Forward Demand, Segmentation, Convenience Yields

    Remarks on Forward Demand, Segmentation, Convenience Yields 1 Forward exchange demand 6≡ Hedging demand 2 Market segmentation central to explain emerging vs. advanced economies 3 Time-varying convenience yields can’t explain CIP devs in emerging economies Proposition 5 (Jiang, Krishnamurthy, and Lus

55. Slide 55: Conclusions

    Conclusions • Currency speculation drives forward demand, shaping CIP deviations. . . 16 / 16

56. Slide 56: Conclusions

    Conclusions • Currency speculation drives forward demand, shaping CIP deviations. . . . . . and thus cost of borrowing, hedging, and monetary policy transmission in EMEs 16 / 16

57. Slide 57: Conclusions

    Conclusions • Currency speculation drives forward demand, shaping CIP deviations. . . . . . and thus cost of borrowing, hedging, and monetary policy transmission in EMEs • Global demand for forwards increases CIP deviations during global recessions • Synthetic peso borrowing more expensive during re

58. Slide 58: Conclusions

    Conclusions • Currency speculation drives forward demand, shaping CIP deviations. . . . . . and thus cost of borrowing, hedging, and monetary policy transmission in EMEs • Global demand for forwards increases CIP deviations during global recessions • Synthetic peso borrowing more expensive during re

59. Slide 59: Appendix

    Appendix 17 / 16

60. Slide 60: Global Forward Demand Predict Returns on Forward Trade

    Global Forward Demand Predict Returns on Forward Trade Note: Preliminary . return 18 / 16

61. Slide 61: Global Forward Demand Earn Profit on Forward Trade

    Global Forward Demand Earn Profit on Forward Trade Note: Preliminary . return 18 / 16

62. Slide 62: Contribution and Related Literature

    Contribution and Related Literature Determinants of Forward Exchange Demand Liao and Zhang (2021); Bacchetta et al. (2024); Bräuer and Hau (2022); Fang and Liu (2021); Jiang et al. (2021) • Propose carry-trade-driven forward demand (6= hedging or convenience yield) • Builds on empirical literature o

63. Slide 63: Foreign Holdings of Bonds and central bank's CDs

    Foreign Holdings of Bonds and central bank’s CDs Figure: Foreign Holdings of Bond and Certificates of Deposit of the Central Bank 40 Number of CDBCRP held by foreigners (in Million) Number of sovereign bonds held by foreigners (in Million) Peru 1M Cross Curr. Basis, Off Fwd, w/ US Interbank Rate (%)

64. Slide 64: Bank hedging: Forward and Spot Positions

    Bank hedging: Forward and Spot Positions • Evidence: Large list of EM showing regulation forces hedging (e.g., Canta (2007), Alfaro et al. (2023), Colombia’s RMV (2019)). Figure: Bank hedging: Forward and Spot Positions 3000 2500 2000 1500 Net Position (Million USD) 1000 500 0 -500 -1000 -1500 Forwa

65. Slide 65: Forward Supply: Local Intermediaries

    Forward Supply: Local Intermediaries • Local intermediary j ∈ [0, 1] holds (a) forward position Kt +1 when supply USD (short USD) ? (b) short-term bond portfolio (Gj,t +1 , Gj,t +1 ), zero-capital • Local intermediary j subject to currency-mismatch regulation: ? 1. unique relationship between Kt +1

66. Slide 66: CIP Deviations and Excess Currency Returns

    CIP Deviations and Excess Currency Returns • 2002-2022 | BRL, CLP, CNY, COP, CZK, HUF, IDR, ILS, INR, KRW, MXN, MYR, PEN, PHP, PLN, RUB, THB, TRY, ZAR rxc,t +3M = αc + δt + βCIP dev3M c,t + ε c,t +3M t = day FX excess returns rxt +3M CIP devt -0.660*** -0.669*** -0.659*** (0.22) (0.23) (0.18) Curren

67. Slide 67: CIP Deviations and Net External Positions

    CIP Deviations and Net External Positions . Return 24 / 16

68. Slide 68: CIP Deviations and Excess Currency Returns

    CIP Deviations and Excess Currency Returns . Return 25 / 16

69. Slide 69: CIP Deviations and Interest Differentials

    CIP Deviations and Interest Differentials . Return 26 / 16

70. Slide 70: CIP Deviations and Net External Positions

    CIP Deviations and Net External Positions . Return 27 / 16

71. Slide 71: Outward-looking Local Interm.'s Profit More From CIP Trade

    Outward-looking Local Interm.’s Profit More From CIP Trade • We exploit the cross-section of banks and find that those banks trading the most with foreign investors are also those that derive higher profits from CIP. 8 Avg. Profits from CIP in the year (w/ adj. dep. rates) 6 4 2 0 Corr: -0.4758 0 20 40

72. Slide 72: References

    Abbassi, P. and F. Bräuning (2020, 10). Demand Effects in the FX Forward Market: Micro Evidence from Banks’ Dollar Hedging. The Review of Financial Studies 34(9), 4177–4215. Aldunate, F., Z. Da, B. Larrain, and C. Sialm (2023). Pension fund flows, exchange rates, and covered interest rate parity. Exch

73. Slide 73: References

    Bräuer, L. and H. Hau (2022). Can time-varying currency risk hedging explain exchange rates? Swiss Finance Institute Research Paper (22-77). Bruno, V. and H. S. Shin (2017, 02). Global Dollar Credit and Carry Trades: A Firm-Level Analysis. The Review of Financial Studies 30(3), 703–749. Cenedese, G.

74. Slide 74: References

    Du, W., A. Tepper, and A. Verdelhan (2018). Deviations from covered interest rate parity. The Journal of Finance 73(3), 915–957. Fang, X. and Y. Liu (2021). Volatility, intermediaries, and exchange rates. Journal of Financial Economics 141(1), 217–233. Fendoglu, S., E. Gulsen, and J.-L. Peydro (2019

Banque Nationale De Belgique — Technical Presentation (December 2024) on 6ix