Foreign Safe Asset Demand and the Dollar Exchange Rate

Zhengyang Jiang, Arvind Krishnamurthy, Hanno Lustig

NBER Working Paper No. 24439
Issued in March 2018, Revised in September 2020
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth, International Finance and Macroeconomics

We develop a theory that links the U.S. dollar’s valuation in FX markets to the convenience yield that foreign investors derive from holding U.S. safe assets. We show that this convenience yield can be inferred from the Treasury basis: the yield gap between U.S. government and currency-hedged foreign government bonds. Consistent with the theory, a widening of the basis coincides with an immediate appreciation and a subsequent depreciation of the dollar. Our results lend empirical support to models which impute a special role to the U.S. as the world’s provider of safe assets and the dollar, the world’s reserve currency.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w24439