We show that dividend-growth predictability by the dividend yield is the rule rather than the exception in global equity markets. Dividend predictability is weaker, however, in large and developed markets where dividends are smoothed more, the typical firm is large, and volatility is lower. Our findings suggest that the apparent lack of dividend predictability in the United States does not uniformly extend to other countries. Rather, cross-country patterns in dividend predictability are driven by differences in firm characteristics and the extent to which dividends are smoothed.

We show that the impact of monetary policy on exchange rates has been growing significantly in recent years. Our results are established by a high-frequency event study of how key fixed income instruments with different maturities respond jointly with exchange rates to monetary policy news from six major central banks. Across countries, news affecting short-term maturity bonds tend to have the strongest impact, highlighting the relevance of communication regarding the path of future monetary policy for exchange rate movements even when policy rates are near their lower bound. We find that the FX impact of monetary policy is state-dependent and is stronger the lower is the level of interest rates, in line with a greater effect through currency risk premia.

Style-based management of the foreign exchange (FX) component of international investments with carry trade, FX momentum, and FX value strategies provides economically large and significant diversification benefits. These speculative benefits go beyond the hedging benefits of FX risk documented in the earlier literature. Our results hold after transaction costs and are confirmed in an extensive out-of-sample experiment mimicking investor decisions in real time. Adding a composite FX style portfolio to diversified allocations of global bonds and stocks leads to a 64% increase in the out-of-sample Sharpe ratio from 0.64 to 1.05, without adverse impact on other portfolio characteristics such as skewness.

How are financial markets pricing the monetary policy outlook? We use surveys to decompose excess returns on money market instruments into expectation errors and term premia. Excess returns are primarily driven by expectation errors, whereas term premia are negligible. Investors face challenges when learning about the Federal Reserve’s response to large, but infrequent, negative shocks in real-time. Rather than reflecting risk compensation, excess returns stem from investors underestimating how much the central bank eases policy in response to such rare shocks. We show, for the US and internationally, that expectation errors imply excess return predictability from past stock returns.

We develop a continuous-time general equilibrium model with intermediaries at the heart of international financial markets. Global intermediaries bargain with households and extract rents from providing access to foreign claims. By tilting state prices, intermediaries’ market power breaks monetary neutrality and makes international risk-sharing inefficient. Despite having zero net positions, markups charged by intermediaries significantly distort international asset prices, affecting exchange rate dynamics and their response to shocks. Our model can reproduce patterns consistent with several well-known exchange rate puzzles, such as deviations from uncovered and covered interest parity. All equilibrium quantities are derived in closed form, allowing us to pin down the underlying economic mechanisms explicitly.

To understand deviations from covered interest parity (CIP), it is crucial to account for heterogeneity in funding costs across both banks and currency areas. For most market participants, the no-arbitrage relation holds fairly well when implemented using marginal funding costs and risk-free investment instruments. However, a few high-rated banks do enjoy CIP-arbitrage opportunities. Dealers avert inventory imbalances stemming from lower-rated banks’ usage of FX swaps to obtain dollar funding by inducing opposite (arbitrage) flows from high-rated banks. Arbitrage trades are difficult to scale, however, because funding costs increase as soon as arbitrageurs increase positions.

We study quantitative easing (QE) policies from a microstructure perspective, drawing on intraday transaction-level data for German bonds (purchased under the Eurosystem’s QE program). An initial analysis of purchase decisions reveals that portfolio managers consider liquidity and the scarcity of securities in repo markets. Suggestive of significant flow effects, we detect price impacts of purchases at high and low frequencies. We find the impact on market liquidity and functioning to be ambiguous. A higher purchase volume lowers transaction costs but has an adverse impact on order-book depth. The price impact varies with market conditions and is higher for more illiquid bonds.

We devise a simple model of liquidity demand and supply to study dealers’ liquidity provision in currency markets . Drawing on a globally representative data set of currency trading volumes, we show that at times when dealers’ intermediation capacity is constrained the cost of liquidity provision increases disproportionately relative to dealer-intermediated volume. Consequently, the otherwise strong and positive relation between liquidity costs and trading volume diminishes significantly when dealers face tighter Value-at-Risk limits or higher funding costs. Using various econometric approaches, we show that this nonlinear effect of dealer constraints on market liquidity primarily stems from a reduction in the elasticity of liquidity supply, rather than changes in liquidity demand.

We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a significant cross-sectional spread in excess returns of up to 10% per annum (p.a.) between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors, it is partially explained by transaction costs and shows behavior consistent with investor under- and overreaction. Moreover, cross-sectional currency momentum has very different properties from the widely studied carry trade and is not highly correlated with returns of benchmark technical trading rules. However, there seem to be very effective limits to arbitrage that prevent momentum returns from being easily exploitable in currency markets.

We assess the properties of currency value strategies based on real exchange rates. We find that real exchange rates have predictive power for the cross-section of currency excess returns. However, adjusting real exchange rates for key country-specific fundamentals (productivity, the quality of export goods, net foreign assets, and output gaps) better isolates information related to the currency risk premium. In turn, the resultant measure of currency value displays considerably stronger predictive power for currency excess returns. Finally, the predictive information content in our currency value measure is distinct from that embedded in popular currency strategies, such as carry and momentum.