Essays on international macro-finance
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The first chapter establishes cross-currency differences in risk-free interest rates as a key determinant of the cost of capital at the firm level. I introduce a new security-level data set of primary market prices of corporate bond issuance and find that violations of uncovered interest rate parity (UIP) directly pass through to firm borrowing costs. As a result, firms that issue debt in currencies with high risk-free interest rates face higher effective funding costs, and, consistent with this finding, firms in countries with higher interest rates have a higher return on assets (ROA). When local currency risk-free interest rates are relatively high, firms are more likely to issue bonds in foreign currency, and when they do so, they appear to be more insulated from the local interest rate environment. This suggests that firms use foreign currency bonds as a way to alleviate domestic financial constraints. The second chapter examines the relationship between international portfolio holdings and asset returns. When foreigners own fewer assets in a particular country, currency returns, interest rates and stock returns are all higher. This finding establishes a connection between two major puzzles in the literature, the carry trade and portfolio home bias, that have mostly been studied in isolation. I develop an international asset pricing model with agency frictions that match the patterns documented in the data. The underlying mechanism suggests a new fundamental explanation for the existence of the carry trade, rooted in limited financial integration, and highlights a new perspective on gross cross-border asset holdings. The third chapter addresses the optimal structure of bank recapitalization policy when sovereign debt is risky. I combine a classic sovereign default model with private sector financial frictions, which generate fully endogenous and time-varying default costs. When the sovereign lacks commitment, I find that the impact of bank recapitalization on sovereign default risk follows a Laffer curve: Public capital infusions can decrease sovereign spreads when domestic banks are weak, even when transfers are fully financed by external borrowing. At the same time, if transfers are excessively large, recapitalization increases sovereign credit risk.
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