Wednesday, November 18, 2020 | 9:00am - 10:30am | ZOOM, Room 337

Abstract

This paper presents a theory of exchange rate determination based on an endogenous liquidity premium. The theory builds on the premise that dollar reserves are the dominant currency in settling international transactions among banks. Financial flows are unpredictable and generate a precautionary demand for dollar reserves when interbank market operate with frictions. We show how the predictions of the model are consistent with the observed empirical relationship between exchange rates, liquidity premia, and dollar-reserve positions.