External financial liabilities and real exchange rate jumps

Abstract

I apply the autoregressive conditional jump intensity (ARJI) model to weekly bilateral real exchange rate (RER) returns of 31 countries over the period 2001–2013 and investigate the causal link between external financial liabilities and bilateral RER jumps. I find that both external debt and equity liabilities significantly reduce RER jumps, above and beyond the standard optimum currency area (OCA) factors, but through different transmission mechanisms. Specifically, I find that while external debt liabilities reduce RER jumps through both a balance-sheet and a risk-sharing channel, external equity liabilities reduce RER jumps only through a risk-sharing channel. Finally, domestic financial development can help attenuate the negative effect of external debt liabilities on RER jumps.