We simulate the impact on the nonbank liabilities of banks in a multiplex interbank environment arising from changes in currency exposure. Currency shocks as a source of financial contagion in the banking sector have not, so far, been considered. Our model considers two sources of contagion: shocks to nonbank assets and exchange rate shocks. Interbank loans can mature at different times. We demonstrate that a dominant currency can be a significant source of financial contagion. We also find evidence of asymmetries in losses stemming from large currency depreciations versus appreciations. A variety of scenarios are considered allowing for differences in the sparsity of the banking network, the relative size and number of banks, changes in nonbank assets and equity, the possibility of bank breakups, and the dominance of a particular currency. Policy implications are also drawn.

Modern investors face a high-dimensional prediction problem: thousands of observable variables are potentially relevant for forecasting. We reassess the conventional wisdom on market efficiency in light of this fact. In our equilibrium model, N assets have cash flows that are linear in J characteristics, with unknown coefficients. Risk-neutral Bayesian investors learn these coefficients and determine market prices. If J and N are comparable in size, returns are cross-sectionally predictable ex post. In-sample tests of market efficiency reject the no-predictability null with high probability, even though investors use information optimally in real time. In contrast, out-of-sample tests retain their economic meaning.