Title: Essays in International Finance and the Global Financial Crisis
Description: This thesis is a compilation of three separate and distinct papers on topics in international finance and the recent financial crisis. Chapter one links the foreign exchange risk premium to macroeconomic risk by studying the options market around macroeconomic news releases. Using a unique data set of overnight currency option prices, I study the reaction of the entire state price density to both anticipated and recently occurring macroeconomic news releases for both US and foreign announcements. I then use intraday data to compare the behavior of the physical pdf around these news releases over the same tenor as the option. I find significant movements in the implied distribution that can be linked to macroeconomic news both ex-ante and ex-post. The volatility risk premium in the overnight options market is large across all currencies, and a strategy that sells insurance through the form of overnight straddles around US non-farm payroll releases earns significant profits. Nonetheless, a significant portion of the volatility risk premium remains that cannot be explained through macroeconomic news despite the short lifespan of these options.

Chapter two studies the evolution of last-resort operations in the recent credit crisis of 2007-2008. The financial crisis that began in 2007 took place in the context of a secular shift from a bank-loan financial system to a capital-markets financial system; that is, from one based on nontradable financial assets, with banks playing the key intermediary role, to one based on tradable securities, with dealers playing the key intermediary role. We argue that the system's response to the crisis can be viewed as moving from a private lender of last resort, through a public lender of last resort, to a dealer of last resort. It was the last that was finally able to stabilize the system, because it is the response suited to a liquidity crisis in the capital-markets financial system where the problem arose. We use a balance-sheet approach to trace out the breakdown of the so-called shadow banking system and the measures taken first in the private money markets and then by the Federal Reserve to restore liquidity to the financial system.

Chapter three studies the effect of hedging imbalances in the foreign exchange market as a possible explanation for deviations from Uncovered Interest Parity. Speculators, becoming weary of holding excess demand for forward hedges, hedge their own exposure in the currency options market. The subsequent increase in option prices is a consequence of this market overhang and is reflected in the implied volatility of currency options. Separating out implied from forecast volatility, we construct a measure of hedging imbalances and add this to the standard UIP regression. For some currencies, a partial rehabilitation of UIP is found.