Essays in International Finance and Macroeconomics

Abstract

This thesis contains three essays in international finance and macroeconomics, which investigate flight-to-safety episodes and their interactions with crises, macroeconomic conditions, fiscal and monetary policy, and bond markets.

The first chapter tackles three questions directly relating to flight-to-safety events and the safe-assets phenomenon. First, can we measure demand for safe assets on a continuum? Second, can we tell what sovereign bonds investors consider safe, and whether the safety of a bond can experience changes (or switches) over time? And third, what are the macro and fiscal dynamics associated with higher safe-assets demand and with safety switches? To answer these questions, I construct a text-based index from newspaper mentions, the FLY, to measure global demand for safe assets. The FLY picks up relevant flight-to-safety episodes and the global savings glut, is priced in the cross-section of sovereign bond returns, and predicts declines in the natural interest rate. I then estimate time-varying loadings on the FLY for many sovereign bonds and use these to identify switches in a bond's safety. Safety switches are associated with sizable movements in macroeconomic variables: positive switches (i.e. becoming safe) are associated with expansions, increases in government spending, and higher debt; conversely, negative switches (i.e. becoming risky) are associated with contractions, decreases in government spending, and lower debt with a shorter maturity structure. The results are driven by advanced economies in the post-global-savings-glut period and are not fully accounted for by credit ratings and crisis periods.

The second and third chapters look at a recent period of crisis and flight to safety, the onset of the Covid-19 pandemic, and shift the focus in two other directions: first, from fiscal policy to monetary policy; and second, from sovereign to municipal bonds. More specifically, the second chapter, joint with Kathryn M.E. Dominguez, looks at unconventional monetary policy, in the form of large-scale sovereign debt purchases and the communication strategy that was used to announce them, during the pandemic. We examine whether open-ended, or "whatever-it-takes", announcements had larger effects than announcements with explicit limits on scale, focusing on government bond markets and exchange rates. We find that on average a central bank’s first whatever-it-takes announcement lowers 10-year bond yields by an additional 47 basis points relative to size-limited announcements. Our results for yields hold for both advanced and emerging economies, while exchange rates go in opposing directions, likely due to the strong flight-to-safety dynamics at play, muting their response when we group all countries together.

The third chapter, joint with Dmitriy Stolyarov, Linda L. Tesar, and Matthew Wilson, investigates pricing anomalies in the US municipal bond market during the flight to safety and liquidity, the dash for cash, that occurred at the onset of the pandemic. Municipal bonds were not considered safe during these period, but their relative perceived safety also experienced a substantial reordering, with a persistent re-ranking of their risk premia during the early months of the pandemic. Conventional factor bond pricing models do not adequately capture these yield dynamics, and neither do added state-level pandemic controls. Instead, we find that during March-September 2020, factors constructed from portfolios sorted on state-level Covid characteristics are the only ones with significant risk premia. A state’s risk premium during Covid depends not on the situation within the state but on the distribution of pandemic intensity across all states.