Martin

IMF Economic Review (2022) 70:487–519
https://doi.org/10.1057/s41308-022-00160-0
RESEARCH ARTICLE
Attention to the Tail(s): Global Financial Conditions

and Exchange Rate Risks
Fernando Eguren‑Martin1,2 · Andrej Sokol2
Published online: 24 March 2022

© International Monetary Fund 2022
Abstract
We document how the entire distribution of exchange rate returns responds to
changes in global financial conditions. We measure global financial conditions as
the common component of country-specific financial condition indices, computed
consistently across a large panel of developed and emerging economies. Using quan-
tile regression, we provide a characterisation and ranking of the tail behaviour of a
large sample of currencies in response to a tightening of global financial conditions,
corroborating (and quantifying) some of the prevailing narratives about safe haven
and risky currencies. Compared to most standard approaches, our methodology
delivers a more nuanced picture of exchange rate behaviour, allowing for example
to make probabilistic statements about the likelihood of observing large swings in
returns given the prevailing global financial environment. We also identify macro-
economic fundamentals associated with different tail dynamics: currencies of coun-
tries with higher interest rates, low levels of international reserves and large fiscal
deficits display more marked increases in the likelihood of large losses in response
to a tightening of global financial conditions.
Keywords Exchange rates · Tail risks · Financial conditions indices · Global

financial cycle · Quantile regression
JEL Classification C22 · F31 · G15
* Fernando Eguren‑Martin
[email protected]
1
SPX Capital, 275 Rua Humaita, Rio de Janeiro, Brazil
2
Centre for Macroeconomics, London, United Kingdom
Vol.:(0123456789)
488 F. Eguren‑Martin, A. Sokol
1 Introduction
Recent years have witnessed a heated debate about the extent and interpretation
of the global co-movement of financial variables. Proponents of a so-called global
financial cycle, beginning with Rey (2013), argue that the observed cross-country
co-movement in asset prices cannot be fully explained by co-movement in real
variables alone and therefore must have a finance-specific component to it, such
as some measure of global risk aversion. Others, such as Cerutti et al. (2017),
argue against the very notion of a ‘global financial cycle’.
Within that debate, there is an asset class that stands out from the rest:
exchange rates. Being relative prices, the scope for them to co-move at the global
level is limited by construction. Moreover, the relationship between exchange
rate movements and overall financial conditions in a country is not a priori obvi-
ous, as a given exchange rate move can have heterogeneous effects across differ-
ent sectors. For example, an exchange rate depreciation can ‘tighten’ access to
finance for agents with net balance sheets exposures in foreign currency (as their
net worth falls and interest payments become more expensive in domestic cur-
rency terms), while ‘loosening’ access for exporters (as their external demand
prospects improve).
Against this backdrop, we study how different exchange rates co-move with
global financial conditions. Given that exchange rates typically exhibit ‘fat tails’
(i.e. non-negligible chances of a large depreciation and/or appreciation), we put a
special emphasis on studying such occurrences, which are of great importance to
both policy makers concerned about financial stability and investors seeking ways
to quantify the value-at-risk of their strategies. In order to do so, and unlike most
of the existing literature, we go beyond mean-based approaches and instead study
the behaviour of the entire distribution of different currencies’ returns in the face
of changes in global financial conditions.
We begin by constructing a new measure of global financial conditions, a prin-
cipal component-based index that has two main advantages over existing alterna-
tives. First, it is truly ‘global’ in nature, drawing from financial asset prices in
more than 40 countries. Second, the within-country coverage across asset classes
is broad, including information from a range of public and private spreads as well
as equity markets. The resulting index closely co-moves with a number of other
commonly used proxies such as the VIX or the indices proposed by Miranda-
Agrippino and Rey (2015), Bekaert et al. (forthcoming) and Chari et al. (2020),
among others, but its ability to fit the tail behaviour of exchange rates is typically
somewhat better. Nevertheless, many of our key results still hold when using
proxies of global financial conditions previously studied in the literature, and
reinforced when such proxies are used jointly with the one we propose.
We then study the co-movement with global financial conditions of a broad set
of currencies. Our point of departure are ‘market narratives’ and earlier contribu-
tions (Ranaldo and Soderlind 2010; Habib and Stracca 2012, among others) that
typically label currencies as ‘safe havens’ or ‘risky’, depending on their perfor-
mance in the face of a tightening of global financial conditions. For example, the
Attention to the Tail(s): Global Financial Conditions and… 489
Japanese yen (JPY) is typically regarded as a ‘safe haven’ currency as it tends to

appreciate on such occasions, while the Australian dollar (AUD) tends to depre-
ciate, and is therefore typically placed in the ‘risky’ camp. In this paper, we go
beyond this narrative characterisation and provide a quantification of the (tail)
risks facing particular currencies under different scenarios for global financial
conditions.
In order to provide quantitative insights, we exploit several novel possibilities
afforded by quantile regression (Koenker and Bassett 1978). Figure 1 shows the
typical output of our regressions for the JPY and AUD, with quantile-specific coeffi-
cients in blue and standard regression coefficients in black. The two panels show the
very different effects of a one standard deviation tightening in global financial con-
ditions on the two currencies: for the JPY, most of the conditional distribution shifts
to the right, increasing the chances of an appreciation, while the pattern for the AUD
indicates an increased risk of a sharp depreciation. Moreover, the pattern of quantile
coefficients highlights that the strongest effects are concentrated in the tails of the
two distributions, which tends to hold across our panel of currencies, and is a feature
that cannot be uncovered using standard regression.
These estimates allow us to provide interesting insights, such as the shift in the
probability of a currency experiencing a depreciation/appreciation of a given mag-
nitude in the face of different scenarios for global financial conditions. So for exam-
ple, when global financial conditions tighten by one standard deviation, the chance
of the AUD experiencing a depreciation of 2.5-5% increases by 5 p.p., while the
corresponding chance of a similar appreciation for the JPY increases by 7 p.p.
(see Table 4). One practical application is the ability to assess the extent to which
some of the large currency moves observed at the height of the COVID-19 crisis
were ‘warranted’ by the concomitant tightening in global financial conditions (see
Sect. 3.4). We also propose intuitive metrics for cross-currency comparisons and
rankings based on tail behaviour.
We also revisit the existing literature on the macro-financial determinants of cur-
rency behaviour (see Fratzscher 2009 and Habib and Stracca 2012, among others)
in light of our expanded focus on the tails. Specifically, we conduct portfolio sorting
exercises based on several macroeconomic fundamentals, and study the responses
of the resulting returns series to a tightening in global financial conditions to iden-
tify potential macro-financial risk factors associated with different currencies’ tail
behaviour. This methodology allows both to introduce a degree of time variation in
the exposure of currencies to a given risk factor and to estimate the effect of these
risks from the entire cross section of currencies in our sample.
We find that currencies of countries displaying high interest rates, low levels
of international reserves, larger fiscal deficits, lower current account balances and
smaller net foreign asset positions display a significantly higher likelihood of depre-
ciating in response to a tightening in global financial conditions. However, only the
first three of those risk factors are associated with a larger ‘crash risk’.1 This exer-
cise also yields a simple tabular mapping from changes in risk factors to shifts in
1
Defined as a depreciation larger than 2.5% in our exercise.
currencies’ tail risks. For example, a country that experiences an 8.2 p.p. increase in
its interest rate differential with respect to the rest of the world should see approxi-
mately a 25 p.p. increase in the probability of its currency depreciating by more than
2.5% in the event of a sharp tightening of global financial conditions. For practi-
tioners, our results provide further empirical motivation for a close scrutiny of the
identified risk factors when assessing countries’ financial stability prospects and the
risks of investment strategies.
1.1 Related Literature
Our paper is related to several literature strands. First, and most directly, it is related
to papers that study the occurrence of tail events in exchange rate markets. On the
negative returns side, there is a large literature that documents the existence of
‘crash’ or ‘disaster’ risk in popular FX strategies. Brunnermeier et al. (2009) find
that carry trade strategies perform particularly poorly during periods of heightened
risk aversion (as proxied by the VIX index), while Menkhoff et al. (2012) show
similar results but focusing on periods of high FX volatility. Relatedly, Farhi and
Gabaix (2016) and Farhi et al. (2009) study disaster risk embedded in option prices.
In principle, the poor performance of carry trades could be the result of both a
sharp depreciation of high-interest-rate currencies and/or a sharp appreciation of
low-interest-rate currencies. In that vein, some papers study the dynamics of par-
ticular currencies, namely those usually labelled as safe havens, which, according
to market narratives, tend to appreciate sharply during periods of high risk aver-
sion. Ranaldo and Soderlind (2010) and Habib and Stracca (2012) study the safe
haven property of a series of currencies, and do indeed find robust evidence of sub-
stantial appreciation during periods of market stress. Fratzscher (2009) also looks at
the dynamics of individual currencies under stress conditions in the context of the
global financial crisis.
A common feature of these papers is that their empirical strategies focus on
the (conditional) mean returns of currencies or trading strategies. In contrast, our
approach allows for a detailed study of the entire distribution of exchange rate
returns, including the tails, which are at the core of our analysis. Moreover, we
propose a novel way of characterising periods of heightened (global) risk aversion,
avoiding popular but imperfect proxies (e.g. the VIX index), or FX-based proxies
which can become somewhat circular (e.g. FX volatility). Moreover, we study a
large panel of exchange rates, facilitating a direct analysis of particular currencies.
The paper is also part of a recent wave of contributions drawing on insights
from quantile regression, originally introduced in economics by Koenker and Bas-
sett (1978), in both macroeconomics and finance. These include Cenedese et al.
(2014) for exchange rates, Gaglianone and Lima (2012) for unemployment, Korobi-
lis (2017) for inflation, Crump et al. (2018) for equity returns, Eguren-Martin et al.
(2020) and Gelos et al. (2019) for capital flows, among several others. Most closely
1.5 1.5
1 1
0.5 0.5
Percentage points
Percentage points
0 0
-0.5 -0.5
-1 -1
-1.5 -1.5
-2 -2
-2.5 -2.5
5 25 50 70 95 5 25 50 70 95
(a) Japan (b) Australia

Fig. 1 Impact of global financial conditions on the conditional quantiles of exchange rate returns, JPY
and AUD. Note The figure shows the coefficients resulting from estimating our baseline specification
for the Japanese yen and the Australian dollar (separately). The blue lines plot the values of 𝛽h (𝜏) across
quantiles, while the black lines show OLS estimates of the same specification. Light blue areas are 68%
confidence intervals are computed from 1000 overlapping block bootstrap draws. (Color figure online)
related to our study, Adrian et al. (2019) rely on quantile regression to characterise
the tails of the GDP growth distribution conditional on domestic financial condi-
tions.2 We build on similar ideas, but focus instead on the distribution of exchange
rate returns conditional on global financial conditions, with many parallels to the
analysis of capital flows’ push factors in Eguren-Martin et al. (2020).
The last strand of literature we draw and build on deals with measurement of
financial conditions. We follow Arregui et al. (2018) in constructing country-specific
financial condition indices that exploit a broad set of market-based indicators for a
large panel of countries, which then allows us to extract a global financial conditions
index. This exercise is related to earlier attempts to characterise a ‘global financial
cycle’, most notably by Miranda-Agrippino and Rey (2015), but in the finance litera-
ture it also overlaps with various proposals to measure global risk aversion and other
factors commonly used to price exchange rate rates (see e.g. Menkhoff et al. (2012)
and Lustig et al. (2011)).3 More recent attempts to characterise financial conditions
drawing from a range of different financial instruments include Chari et al. (2020)
and Bekaert et al. (forthcoming).
The rest of the paper is organised as follows: in Sect. 2, we describe our measure
of global financial conditions. In Sect. 3 we discuss quantile regressions of nominal
effective exchange rate returns on global financial conditions. In Sect. 4 we intro-
duce a currency portfolio sorting approach based on macroeconomic fundamentals
2
Relatedly, Adrian et al. (2018) explore the term-structure of this relationship.
3
See Cerutti et al. (2017) for a contrarian view on the existence of a global financial cycle. Also see
Drehmann et al. (2012) for a characterisation of a more medium-term (domestic) financial cycle.
that allows us to identify potential factors associated with currencies’ differential tail
behaviour. In Sect. 5 we run a series of robustness checks on our results. In Sect. 6
we conclude, while the Appendix includes details about our data and methodology.
An online appendix provides additional results and robustness checks.
2 Measuring Global Financial Conditions
The existence of a global factor in financial conditions has been widely debated in
economics over recent years.4 Beginning with Rey (2013), a series of papers have
emphasised (and measured) a strong co-movement in financial variables across
countries (among others, see Bruno and Shin (2014), Cesa-Bianchi et al. (2018a,
2018b), Ha et al. (2018)). These papers have suggested that this co-movement in
financial conditions goes beyond a reflection of co-movement in macroeconomic
indicators, and hence is at least partly driven by a specific global factor in financial
variables, such as risk appetite. The standard approach has been to measure common
variation in a set of asset prices and/or credit quantities, interpreting the result as an
indicator of the ease at which finance could be accessed at a given time in a given
country (see, for example, Miranda-Agrippino and Rey (2015)).
Existing measures of global financial conditions typically suffer from two short-
comings. First, the breadth of financial series considered tends to be limited, and
usually skewed towards equity markets (as, for example, in Miranda-Agrippino and
Rey (2015)). Second, the geographical coverage tends to be limited to advanced
economies (e.g. Ha et al. (2018)) and, in some cases, a handful of emerging coun-
tries. Both of these limitations are due to data availability constraints: it is not
straightforward to construct a panel dataset spanning a broad set of financial indica-
tors for a large cross section of countries.
In order to overcome these limitations we follow Arregui et al. (2018) and con-
struct a panel dataset covering a broad set of monthly financial indicators for 43
countries from April 1995 to June 2018. The financial series included are as follows:
term, sovereign, interbank and corporate spreads, long-term interest rates, equity
returns and volatility and relative market capitalisation of the financial sector.5 We
rely on principal component analysis to extract country-specific summary measures
of financial conditions (which correspond to the first principal component of the
series considered).6
4
This factor has typically been referred to as ‘the global financial cycle’.
5
A detailed description of the variables used and corresponding data sources can be found in Appen-
dix A.
6
Note that the resulting first principal component of the series considered is very similar to the common
factor obtained when following Arregui et al. (2018) and relying on the method of Koop and Korobilis
(2014), which allows for time variation in the parameters and attempt to ‘clean’ financial conditions from
changes that reflect a response to macro-economic news (proxied by industrial production and CPI infla-
tion). This can be interpreted as a result of the relative stability of the parameters and the fact that asset
prices tend to react to news about expected rather than realised macroeconomic aggregates. Arrigoni
et al. (2020) reach a similar conclusion.
Armed with a set country-specific financial condition indices, we then compute a

global component simply as their cross-sectional mean.7
The share of variance of individual countries’ FCIs explained by this global com-
ponent varies in the cross section, but averages around 35%. It is worth noting that
this figure goes well above 50% for several countries, including financial centres
such as the US or the UK (see Sect. 1 of the Online Appendix). In what follows we
take this series as our measure of global financial conditions.
Figure 2 shows that the evolution of our measure over the last 20 years is broadly
in line with prevailing financial market narratives (see e.g. Brunnermeier 2009; Ros-
tagno et al. 2021): for example, the left panel shows that global financial conditions
tightened sharply around the collapse of Lehman Brothers in 2008 or the euro area
crisis of 2010-2012. The right panel also highlights that our measure exhibits both
skewness and kurtosis (fat tails), meaning both that tightenings in global financial
conditions have tended to be somewhat larger than loosenings, and that larger out-
turns have occurred more frequently than implied by a standard Normal distribution.
These features are shared by many of the existing proxies of global financial condi-
tions, as shown in Table 1.
Table 2 also shows the correlation of our index with other proxies previously used
in the literature to measure both global financial conditions and narrower conditions
in FX markets. Our proxy co-moves positively, but far from one-to-one, with other
widely used US-centric measures such as the VIX index or TED spreads, and with
the estimated factors in Miranda-Agrippino and Rey (2015), Bekaert et al. (forth-
coming) and Chari et al. (2020). In the context of this paper, it is also interesting
to note that our measure of global financial conditions displays heterogeneous cor-
relations with factors previously used to price exchange rates: it displays a relatively
high correlation with the FX volatility factor in Menkhoff et al. (2012), but very low
correlations with the dollar and HML factors in Lustig et al. (2011). This is particu-
larly interesting because these factors are computed using the very same exchange
rate data that are then priced with them, while our measure does not directly contain
any FX data at all.
While our proposed measure arguably represents an improvement over existing
proxies of the global financial cycle in terms of both geographical and asset class
coverage, many of our results on the link between global financial conditions and
exchange rates’ tail behaviour do not rely on it and hold through with a number of
the proxies listed in Table 2. Section 5.4 elaborates on this point, but also shows that
even if the various proxies are typically highly correlated, there can still be signifi-
cant gains in fit in the tail regions of exchange rate returns from their joint inclusion
as explanatory variables.
7
Taking the first principal component of the indices yields an almost indistinguishably similar series,
see Sect. 1 of the Online Appendix.
3 Assessing Exchange Rate Tail Risks with Quantile Regression
As discussed in Sect. 2, asset prices tend to display a high degree of co-movement

across countries. However, exchange rates are somewhat special. Being relative
prices, the pattern and extent of their co-movement is more constrained than for
other assets. This feature is the departing point of our analysis: we want to under-
stand how different exchange rates co-move with changes in global financial con-
ditions, and the underlying country-specific characteristics that are associated with
such dynamics.
Our focus is on the entire distribution of exchange rate returns, and in particu-
lar on tail events. Specifically, we study how the likelihood of sharp exchange rate
movements (in either direction) is affected by global financial conditions. To this
end, we rely on quantile regression, originally introduced in economics by Koenker
and Bassett (1978) and recently popularised by Adrian et al. (2019), among oth-
ers. Unlike standard regression, which provides an estimate of the conditional mean
of a variable of interest given a set of explanatory variables, quantile regression
allows to model the entire conditional distribution of a dependent variable given a
set of covariates. This allows to capture features that are lost when only focussing
on the average response, as already highlighted in our discussion of Fig. 1 in the
Introduction.
Given our special emphasis on measuring tail risks, it is worth highlighting that
quantile regression also offers at least one important advantage relative to probit/
logit-type frameworks, for example as applied to capital flows surges and retrench-
ments by Forbes and Warnock (2012) (see also the discussion in Eguren-Martin
et al. 2020). In such frameworks, the tails events need to be defined ex-ante with ref-
erence to ad-hoc thresholds. In contrast, quantile regression allows to directly map
risk factors to any part of the conditional distribution of a variable of interest. The
same logic applies to the analysis of exchange rates.
3.1 Specification
Following the (limited) existing literature applying quantile regression to exchange

rates (see, for example, Cenedese et al. 2014), our baseline exercise studies the effect
of global financial conditions on the distribution of exchange rate returns. We spec-
ify a linear model for their conditional quantiles as follows:
QΔFXt+h (𝜏|Xt ) = 𝛼h (𝜏) + 𝛽h (𝜏)GFCt (1)
where ΔFXt+h is the monthly log change in the nominal effective exchange rate
h months ahead and GFCt is our measure of global financial conditions.8 Q thus
denotes the 𝜏−th quantile of the distribution of ΔFXt+h conditional on a set of
8
The convention we adopt here is that positive FX changes represent an appreciation, and negative
changes a depreciation. This is done in order to facilitate comparison with the next section, which looks
at returns.
5
0.5
Skewness: 1.9
4
Kurtosis: 9
0.4
Standard deviations
Probability density
3
2 0.3
1 0.2
0
0.1
-1
0
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -1 0 1 2 3 4 5
Standard deviations
(a) Time series (b) Histogram

Fig. 2 Global Financial Conditions Index, 1995-2018. Note The figure shows the time series of our
Global Financial Conditions Index. The index is standardised, so has zero mean and unit variance over
the whole sample. Higher values signal tighter financial conditions
Table 1 Higher moments of GFCI VIX MAR RORO BEX

selected proxies of global
financial conditions Skewness 1.9 1.9 0.6 2.0 3.8
Kurtosis 9.0 9.0 3.4 8.5 21.2
The table show the skewness and kurtosis of the series over their
respective samples. Positive skewness indicates that the mean of the
distribution is larger than its mode, i.e. the distribution is skewed to
the right. A kurtosis larger than 3 indicates ‘fatter tails’ than a stand-
ard Normal benchmark. GFCI refers to our Global Financial Condi-
tions Index, VIX to the VIX index, MAR to the index from Miranda-
Agrippino and Rey (2015), RORO to the (cumulated) index from
Chari et al. (2020) and BEX to the index in Bekaert et al. (forthcom-
ing)
covariates Xt (in this case, GFCt and a constant). Appendix B provides technical
details.
Equation (1) is very parsimonious, but we have found that it reliably captures
the impact of GFCt on the conditional quantiles of exchange rate returns. Con-
sidering alternative functional forms and additional regressors does not results
in significant changes to the estimates of 𝛽h (𝜏) from the baseline linear specifi-
cation (while it can of course increase in-sample fit, see Table 6). For example,
we have tried adding a quadratic term in order to capture potential nonlineari-
ties, and experimented with adding (i) lags of ΔFXt+h , (ii) additional regressors
that aim at capturing the factor structure usually found in exchange rates (spe-
cifically the ‘dollar’ and ‘carry’ factors in Lustig et al. 2011 and (iii) alternative/
additional proxies of global financial conditions found in the literature (for exam-
ple Miranda-Agrippino and Rey 2015; Bekaert et al. (forthcoming); Chari et al.
2020). Some of these exercises are discussed in more detail in Sect. 5.
496
Table 2 Correlation between Global Financial Conditions Index and selected variables
GFCI VIX TED S&P FXVOL MAR MARII HML DOL DOLII BEX RORO
GFCI 1.00 0.81 0.49 0.31 0.68 0.71 0.62 0.04 0.02 0.22 0.83 0.73
VIX 0.81 1.00 0.50 0.36 0.73 0.61 0.54 –0.12 –0.28 0.19 0.88 0.78
TED 0.49 0.50 1.00 –0.07 0.45 0.27 –0.18 –0.13 –0.14 0.17 0.46 0.25
S&P 0.31 0.36 –0.07 1.00 0.09 –0.04 0.36 –0.72 –0.63 0.16 0.22 0.63
FXVOL 0.68 0.73 0.45 0.09 1.00 0.59 0.45 0.13 –0.03 0.25 0.74 0.70
MAR 0.71 0.61 0.27 –0.04 0.59 1.00 0.74 0.37 0.31 0.12 0.80 0.84
MARII 0.62 0.54 –0.18 0.36 0.45 0.74 1.00 0.24 0.19 0.07 0.64 0.90
HML 0.04 –0.12 –0.13 –0.72 0.13 0.37 0.24 1.00 0.86 –0.10 0.07 –0.10
DOL 0.02 –0.28 –0.14 –0.63 –0.03 0.31 0.19 0.86 1.00 –0.13 –0.09 –0.11
DOLII 0.22 0.12 0.07 0.19 0.25 0.17 –0.16 –0.10 –0.13 1.00 0.21 0.05
BEX 0.83 0.80 0.64 0.88 0.74 0.46 –0.22 0.07 –0.09 0.21 1.00 0.77
RORO 0.73 0.84 0.90 0.78 0.70 0.25 –0.63 –0.10 –0.11 0.05 0.77 1.00
The table show correlations between series measured over common samples, which vary across pair of indices. GFCI stands for our Global Financial Conditions Index,
MAR and MAR II are the ‘short’ and ‘long’ factors in Miranda-Agrippino and Rey (2015) respectively, VIX is the VIX index, TED stands for TED spreads, S&P for the
(negative of) the S&P500 Index, FXVOL for the volatility factor in Menkhoff et al. (2012) and FX HML and DOL for the HML and dollar factors in Lustig et al. (2011).
DOLII is the broad dollar index from the BIS (as proposed in Avdjiev et al. (2019)). BEX is the financial conditions index in Bekaert et al. (forthcoming) and RORO is
(the cumulative version of) the index put forward by Chari et al. (2020)
F. Eguren‑Martin, A. Sokol
Australia Japan Euro area

1.5 1.5 1.5
Percentage points
Percentage points
Percentage points
1 1 1
0.5 0.5 0.5
0 0 0
-0.5 -0.5 -0.5
-1 -1 -1
-1.5 -1.5 -1.5
-2 -2 -2
-2.5 -2.5 -2.5
5 25 50 70 95 5 25 50 70 95 5 25 50 70 95
Switzerland United Kingdom United States

1.5 1.5 1.5
Percentage points
Percentage points
Percentage points
1 1 1
0.5 0.5 0.5
0 0 0
-0.5 -0.5 -0.5
-1 -1 -1
-1.5 -1.5 -1.5
-2 -2 -2
-2.5 -2.5 -2.5
5 25 50 70 95 5 25 50 70 95 5 25 50 70 95
Fig. 3 Impact of global financial conditions on the conditional quantiles of exchange rate returns,
selected currencies. Note The figure shows the coefficients resulting from estimating our baseline speci-
fication for each selected currency (separately). The blue lines plot the values of 𝛽h (𝜏) across quantiles,
while the black lines show OLS estimates of the same specification. Light blue areas are 68% confidence
intervals are computed from 1000 overlapping block bootstrap draws. (Color figure online)
We estimate Eq. (1) on a currency-by-currency basis for a panel of 61 countries

from April 1995 to June 2018. The full list of currencies can be found in Appen-
dix A. In our baseline, we focus on nominal effective exchange rates to identify idi-
osyncratic dynamics in exchange rate returns, rather than on potentially US-driven
dollar bilaterals.9 Also, following the existing literature (e.g. Habib and Stracca
2012; Cenedese et al. 2014), we focus on the contemporaneous (monthly) relation-
ship, i.e. on h = 0.
Figure 3 reports coefficient estimates of 𝛽0 (𝜏) in the same format as Fig. 1, but
now for a set of ‘popular’ currencies.10 As previously discussed, the responses of the
Japanese yen and the Australian dollar to a tightening of global financial conditions
are starkly different, and corroborate their typical labelling as safe-haven and risky,
respectively. The Swiss franc and the US dollar are also firmly in the safe-haven
camp where market narratives typically place them: across quantiles, their coeffi-
cients are either larger than or statistically not different from 0, and increasing for
higher quantiles, meaning that when global financial conditions deteriorate, the dis-
tribution of their returns shifts and skews to the right, making large appreciations
more likely.
9
See Sect. 5 for a robustness exercise which re-estimates our baseline specification considering US dol-
lar bilateral exchange rates, and another one that considers excess returns instead of plain exchange rate
changes.
10
The full set of coefficient estimates for our panel of currencies is reported in Sect. 2 of the Online
Appendix.
On the other hand, our estimates for the UK pound suggest that it tends to behave
like a risky currency, as its coefficients are mostly negative, and more so for lower
quantiles. The euro is an interesting intermediate case, perhaps owing to the gradual
evolution of its underlying economic and political underpinnings over our sample. It
exhibits some features of a risky currency, with slightly negative coefficients up to
the median, but also clear marks of safe haven status, with large and increasing coef-
ficients in the upper tail.
In the following subsections, we build further on these initial intuitions, and
showcase how our regression estimates can be turned into quantitative insights for
practitioners and policy-makers.
3.2 Goodness of Fit
Quantile-specific measures of goodness of fit represent a distinctive advantage of

quantile regression over more traditional approaches that focus on the conditional
mean, and provide an intuitive quantification of the role played by global financial
conditions in driving tail behaviour for different currencies. We follow Koenker
and Machado (1999) and report quantile-specific R1 (𝜏) measures for all currencies.
Unlike standard R2 measures, which quantify the relative success of two models for
the conditional mean function, and thus provide a global measure of goodness of fit
over the entire conditional distribution, R1 (𝜏) measures provide information on the
relative local success of two models of a conditional quantile function.
The (adjusted) R1 (𝜏) is defined as
̂
V(𝜏) T −1
R1 (𝜏) = 1 − (2)
̃
V(𝜏) T − k
where V(𝜏)
̂ denotes the sum of weighted absolute residuals of model (1) and V(𝜏)
̃ the
sum of weighted absolute residuals of a model consisting only of a constant (which
provides an estimate of the unconditional quantile 𝜏 ).11 T denotes the length of the
sample, and k the number of coefficients in the more complex model. The interpre-
tation is thus analogous to that of standard R2: R1 (𝜏) expresses the improvement in
fit, in terms of the relevant criterion function, obtained by adding covariates to the
model, with a small penalty for the number of additional coefficients.
Table 3 reports both R2 and R1 (𝜏) measures for the same selection of currencies
shown in Fig. 3. The first thing to note is that the overall improvement in fit from
including our measure of global financial conditions as a covariate, proxied by the
R2 of a standard OLS regression, varies across countries, and can be rather limited.
On the other hand, as far as R1 (𝜏) measures are concerned, a robust pattern
seems to hold across countries, namely, that the goodness of fit tends to generally
11
As explained in Appendix B, V(𝜏)
̂ and V(𝜏)
̃ are simply the objective functions of the respective quan-
tile regression problems, which take the form of weighted sums of absolute residuals, evaluated at the
optimum.
improve in the tails, highlighting the information content of global financial condi-
tions that can be lost by exclusively focusing on the conditional mean of exchange
rate returns.12 It is also worth noting that the improvements tend to be concentrated
in one tail, and the largest gains tend to accrue to the most extreme percentiles, so
the 95th for the Japanese yen, Swiss franc, US dollar and the euro, and the 5th for the
Australian dollar and UK pound.
3.3 Summary Measures of Tail Behaviour
The information conveyed by quantile-specific coefficients estimates can also be

summarised visually by studying their effect on fitted probability density functions.
In the same spirit as Adrian et al. (2019), who fit skew-t distributions to the predic-
tive quantiles of GDP growth, we fit nonparametric density functions to the quan-
tiles of exchange rate returns conditional on different values of global financial con-
ditions.13 This counterfactual exercise allows both to visualise in an intuitive way
the behaviour implied for each currency by our estimates, and to rank currencies
based on their tail behaviour. Appendix B provides technical details.
Figure 4 illustrates the changes induced by a one standard deviation increase in
global financial conditions on the conditional densities of the same set of currencies
analysed before.14 Focussing again on the JPY and AUD, the right (appreciation) tail
of the distribution of the Japanese yen shifts up significantly (increased chances of a
sharp appreciation), while the left (depreciation) tail of the distribution of the Aus-
tralian dollar shifts down (increased chances of a sharp depreciation). Similarly, the
exercise implies a ‘fattening’ of the right tail of the euro, the Swiss franc and the US
dollar, and of the left tail of the UK pound. These ‘fatter’ tails thus not only confirm
market narratives but, most importantly, also provide a quantification of the shift in
risks.
To compare such heterogeneous tail behaviour across currencies, we compute
measures of divergence between each pair of distributions in Fig. 4. In particular,
we use a version of the Kullback–Leibler divergence, also known as relative entropy,
to quantify the ‘shifts’ induced in the tail regions by a tightening of global financial
conditions.15 Given a fitted distribution ĝ (x) conditional on average global financial
conditions and another, f̂ (x), conditional on a one standard deviation increase in
global financial conditions, we compute downside and upside (relative) entropy out-
side of the interquartile range of ĝ (x) as
12
This also holds in term of the full panel of currencies, see Sect. 2 of the Online Appendix.
13
The reason for using a nonparametric distribution is to allow for a more nuanced depiction of tail
behaviour than is possible by only fitting a few parameters (four in the case of the skew-t) to the esti-
mated conditional quantiles, which is particularly important in our application. A related approach, also
based on kernel densities, is followed by Gaglianone and Lima (2012) and Korobilis (2017).
14
For the full panel see Sect. 2 of the Online Appendix.
15
This is similar in spirit to the quantification of upside and downside risks in Adrian et al. (2019).
Table 3 Goodness of fit

R1 (𝜏) R2
measures, selected currencies
0.05 0.25 0.5 0.75 0.95
Australia 16.2 2.5 –0.2 –0.3 1.3 4.1

Euro area 0.7 –0.1 –0.4 0.2 9.9 –0.2
Japan 2.0 0.3 1.4 5.5 13.8 5.4
Switzerland –0.3 –0.2 2.4 3.8 6.5 1.9
United Kingdom 7.6 1.9 0.3 –0.3 –0.2 1.8
United States –0.2 0.0 1.6 1.7 7.2 4.4
The table shows quantile-specific goodness of fit measures R1 (𝜏)

across currencies, which are computed as shown in Eq. 2, following
Koenker and Machado (1999) but adjusting for the number of model
parameters. For OLS regressions, the adjusted R2 is computed in the
usual way
̂ −1 (0.25)
G ( )
f̂ (x) ̂
∫−∞
D
L = log f (x)dx (3)
ĝ (x)
∞ ( )
f̂ (x) ̂
∫Ĝ −1 (0.75)
(4)
U
L = log f (x)dx
ĝ (x)
Intuitively, downside and upside entropy measure the additional probability mass
assigned to tail events when there is a tightening of global financial conditions. For
safe haven currencies, upside entropy should be positive (denoting an increased
probability of a large appreciation), whereas for risky currencies, downside entropy
should be positive.
Figure 5 shows the results for the same selection of currencies as Fig. 4.16 The
ranking in terms of tail behaviour once again broadly confirms prevailing narratives:
typical safe haven currencies such as the Japanese yen and the Swiss franc exhibit
high upside entropy but hardly any downside entropy, whereas risky currencies such
as the Australian dollar tend to exhibit a higher downside entropy. Both the US dol-
lar and the euro display a similarly high upside entropy (‘safe haven’-type behav-
iour), but it is worth noting that when repeating the exercise for bilateral exchange
rates we find an increased likelihood of a sharp euro depreciation vis-à-vis the US
dollar (high downside entropy) in the event of a tightening in global financial condi-
tions (see Sect. 5.2).
To provide a more tangible measure, Table 4 also reports changes in appreciation
and depreciation probabilities induced by a tightening of global financial conditions;
that is, the integral of f̂ (x) − ĝ (x) over different ranges. Very large swings in returns
in either direction (>5%) are never assigned very high probabilities, whereas appre-
ciations or depreciations between 2.5% and 5% tend to be assigned higher chances,
16
See Sect. 2 of the Online Appendix for the full sample of currencies.
Australia Japan Euro area

0.5 0.5 0.5
Probability density
Probability density
Probability density
0.4 0.4 0.4
0.3 0.3 0.3
0.2 0.2 0.2
0.1 0.1 0.1
0 0 0
-10 0 10 -10 0 10 -10 0 10
% change % change % change
Switzerland United Kingdom United States

0.5 0.5 0.5
Probability density
Probability density
Average GFC
Probability density
0.4 0.4 0.4 1 s.d. GFC
0.3 0.3 0.3
0.2 0.2 0.2
0.1 0.1 0.1
0 0 0
-10 0 10 -10 0 10 -10 0 10
% change % change % change
Fig. 4 Impact of a tightening of global financial conditions on the conditional distribution of exchange
rate returns. Note The panels show, for each currency, nonparametric probability densities fitted to our
estimated quantiles conditioning on an average (zero) value of global financial conditions (in blue), and
on a one standard deviation increase in global financial conditions (in red). (Color figure online)
0.3
Downside entropy (depreciation risk)
0.25 Upside entropy (appreciation risk)
0.2
Entropy measure
0.15
0.1
0.05
-0.05
-0.1
om
s
nd
ia
ea
n
e
pa
l
ra
at
la
ar
d
Ja
ng
St
er
st
ro
Au
itz
Ki
d
Eu
te
Sw
d
ni
te
U
ni
U
Fig. 5 Downside and upside entropy measures of conditional exchange rate returns, selected currencies.
Note The figure shows downside and upside entropy measures for a series of currencies, as defined in
Eqs. (3) and (4). A positive entropy denotes a higher probability mass assigned to outturns in the cor-
responding tail by the distribution conditional on tighter global financial conditions than the distribution
conditional on average global financial conditions. Black lines quantify 68% confidence intervals to these
measures, computed from 1000 overlapping block bootstrap draws. (Color figure online)
Table 4 Changes in appreciation and depreciation probabilities due to a tightening of global financial
conditions, selected currencies
Depreciation probability Δ Appreciation probability Δ
>5% 2.5–5% 0–2.5% 0–2.5% 2.5–5% >5%
Australia 3.3 4.9 –5.6 –4.4 1.4 0.3

Euro area 0.0 0.9 0.5 –7.7 6.2 0.0
Japan 0.9 0.2 –8.5 –2.5 6.8 3.1
Switzerland 0.0 0.3 –7.8 1.7 6.0 0.0
United Kingdom 0.0 3.1 1.9 –6.4 1.4 0.0
United States 0.0 0.1 –7.6 5.6 1.8 0.0
The table shows changes in appreciation and depreciation probabilities for each currency implied by a
shift from the blue to the red distributions shown in Fig. 4, expressed in percentage points
mostly in accord with usual currency characterisations. These results thus comple-
ment and qualify the information about local fit from R1 (𝜏) measures, and give a
much more nuanced depiction of different currencies’ tail behaviour.
Such information has many potential applications. For example, in the Online
Appendix we attempt a classification of currencies into safe haven-like, risky or
generically volatile on that basis (see Sect. 2 of the Online Appendix). Our work-
ing definition of safe haven-like behavior applies to currencies that exhibit positive
upside entropy and negative downside entropy (so that tail risks shift to the upside
as global financial conditions tighten), while risky currencies are defined through
the opposite behaviour (so that tail risks shifts to the downside in the same situa-
tion); a third category collects currencies that do not fit either pattern. However, a
few words of caution are in order. First of all, even 68% confidence bands around
our entropy estimates can be wide, so the results need to be treated accordingly. For
example, our point estimate for Australia’s upside entropy is marginally positive,
though statistically insignificant (see Fig. 5) so that in our sample, its currency ends
up in the third category rather than in the risky one. Moreover, despite the exercise
being done on a NEER basis, the currencies of countries with an exchange rate peg
and/or members of a monetary union will tend to display dynamics very much in
line with their anchor currencies. This for example explains Peru and Bulgaria’s oth-
erwise surprising presence in the safe haven-like category.17
3.4 An Application to the COVID‑19 Crisis
The sharp currency moves observed amidst the turmoil in global financial markets
over March 2020, when the COVID-19 pandemic was sharply accelerating, offer a
good setting in which to showcase the advantages of our modelling approach. We
do so by feeding our models for the Japanese yen and the Australian dollar from
17
According to Ilzetzki et al. (2021), Peru had a tight crawling band around the US dollar for a large
part of our sample, while Bulgaria had a peg, first to the German mark and then to the euro.
Sect. 3 the observed value of our global financial conditions index for March 2020,
and using the resulting conditional distributions to compare the likelihood of the
observed currency moves to that implied by average global financial conditions.18
Figure 6 reports these distributions, with outturns shown by the black stars. As
expected, as global financial conditions tightened sharply, the conditional distribu-
tions skewed to the right for the yen and to the left for the Australian dollar. This
happened as the yen appreciated by almost 4% and the Australian dollar depreciated
by almost 6%. The likelihood of observing such (or larger) moves in FX returns
is negligible under average global financial conditions (about 3% and 0.1% for the
yen and Australian dollar, respectively) but increases markedly once one takes into
account concomitant changes to global financial conditions (to about 30% and 15%
for the yen and Australian dollar, respectively).
This exercise shows the usefulness of our model for (i) putting realised currency
moves in context by considering changes in global financial conditions and (ii)
assigning (conditional) probabilities to every possible FX outturn. In this particu-
lar instance, we can see that changes in the value of both the Japanese yen and the
Australian dollar were relatively ‘extreme’ even once the concomitant deterioration
in global financial conditions is taken into account, but their likelihood is neverthe-
less much higher than in a situation in which global financial conditions are closer to
their sample mean.
In the next Section we turn to analysing the underlying country characteristics
that are associated with such different responses of currencies’ distributions to
changes in global financial conditions.
4 Identifying Risk Factors: A Portfolio Sorting Approach
What country-level characteristics are associated with the different exchange rate
dynamics documented in the previous section? Or, in other words, are there any
risk factors associated with specific tail behaviours that policymakers and investors
should keep track of? To answer this question, in this Section we draw on portfolio
sorting techniques, popular in the FX and equity pricing literatures. In Sect. 4.1 we
explain the rationale and mechanics behind our portfolio sorting exercises, while
in Sect. 4.2 we identify relevant risk factors by studying the returns, in the face of
changes in global financial conditions, of portfolios constructed on their basis.19
As a tangible output potentially useful for practitioners, we provide a simple tabu-
lar mapping between changes in a particular risk factor and increases in currency
returns’ tail risk.
18
It should be noted that this is not an out-of-sample exercise, as we are feeding the model observed
monthly global financial conditions, which are only available at the end of the month just like the left-
hand-side variable. Of course, more timely (e.g. weekly or daily) assessments of global financial condi-
tions could be constructed and used to properly nowcast/forecast monthly exchange rate returns.
19
Throughout the current exercise we do not consider eurozone currencies given the asymmetry
between national/domestic risk factors and a zone-wide currency whose value individual countries can
only partially influence.
0.25 0.25
Average distribution Average distribution
March 2020 distribution March 2020 distribution
March 2020 outturn March 2020 outturn
0.2 0.2
Probability density
Probability density
0.15 0.15
0.1 0.1
0.05 0.05
0 0
-10 -5 0 5 10 -10 -5 0 5 10
Monthly FX change (%) Monthly FX change (%)
(a) Japan (b) Australia
Fig. 6 Conditional distributions and outturns during the COVID-19 outbreak in March 2020. Note The
panels show, for each currency, nonparametric probability densities fitted to our estimated quantiles con-
ditional on an average (zero) value of global financial conditions (in blue), and on the value of global
financial conditions observed in March 2020 (3.7 standard deviations, in red). Overlaid is the realised
value of the respective NEERs’ returns in March 2020 (black star). (Color figure online)
4.1 Portfolio Sorting
Identifying country characteristics associated with the individual features of

exchange rate returns distributions documented in Sect. 3 is challenging: for each
country, conditional distributions are estimated from the whole (time series) sample
and offer a single summary statistic. However, it is likely that the risk factors associ-
ated with such dynamics change over time. For example, it would not be appropriate
to try to associate a certain conditional exchange rate distribution to average fiscal
deficits over 25 years, as this statistic is likely to hide significant variation over the
sample. To address such concerns, we need to introduce a degree of time-variation
in our analysis. To do so, we conduct a set of portfolio sorting exercises, widely used
in the equity and FX pricing literatures (see Cenedese 2015, and references therein).
We start from a series of candidate variables that have been identified in the lit-
erature as being associated with particular reactions of exchange rates to changes in
global financial conditions: interest rate differentials (versus the rest of the world),
current account balances, fiscal balances, net foreign assets and levels of interna-
tional reserves.20 A series of empirical papers have analysed the importance of these
risk factors for average exchange rate dynamics: Brunnermeier et al. (2009), Lustig
et al. (2011) and Menkhoff et al. (2012) study the risk features of high interest rate
currencies, Della-Corte et al. (2016) that of currencies of countries with large exter-
nal imbalances, while Fratzscher (2009) and Habib and Stracca (2012) assess the
relevance of a wide range of variables, including fiscal balances, net foreign assets
20
Exact definitions and data sources can be found in Appendix A. Interest rate differentials are implied
from FX forward contracts. Note that recent CIP deviations mean that there is measurement error in this
quantification of interest rate differentials for a portion of our sample.
and international reserves, for currency returns. In turn, these studies are grounded
on a rich history of theoretical work linking these macroeconomic variables and
exchange rate dynamics.21,22
We consider each of the candidate risk factor variables in turn and, at each point
in time throughout our sample, begin by ranking countries according to the values
they display for the variable under consideration. So, for example, when working
with current account balances, we rank countries from those displaying the highest
current account surplus to those with the highest deficit.23
We then assign currencies to three portfolios according to this ranking. Continu-
ing the previous example, the first portfolio contains the currencies with the largest
current account deficits (the ‘riskier’ set of currencies if current account deficits are
indeed a risk factor), while the third portfolio contains the currencies with the larg-
est current account surpluses (the ‘safest’ group).24 Finally, we compute the return
of each portfolio over the month as the equally weighted return of its component
currencies.25
The advantage of such a portfolio sorting approach is that it introduces time
variation in the exposure to risk factors, which could be associated with particular
exchange rate dynamics. This is achieved by allowing countries to have different
levels of exposure at different points in time. For example, country A could exhibit a
large current account surplus in period t and a large deficit in period t+k. In this situ-
ation, the return of country A’s currency in period t will be assigned to the portfolio
comprising surplus countries, while the return in period t+k will be assigned to the
portfolio comprising deficit countries. By doing this, our estimates do not depend
on the whole time series of returns of a particular country or group of countries, but
instead returns are computed dynamically depending on where countries lie in the
ranking of risk factors.26
We conduct the exercise described above separately for each of the risk fac-
tors considered over 1995-2016, and then analyse how exposure to each of them
is associated with different tail behaviour in the face of changes in global financial
conditions.
21
See, for example, Krugman (1979), Dornbusch and Fischer (1980), Wijnbergen (1991), Obstfeld and
Rogoff (1995) and Gabaix and Maggiori (2015).
22
Strictly speaking, there is no need for a structural macroeconomic link between the risk factors con-
sidered and the exchange rate; as long as investors believe these to be risk factors, and act accordingly,
we could still observe the expected conditional correlations, at least in the short run.
23
We rebalance portfolios annually given the limited availability of data for the sorting variables.
24
See Sect. 5 for a robustness exercise which considers an alternative version of the portfolio sorting in
which the assignment of currencies to risk buckets is performed according to lagged values of the risk
variables under consideration.
25
We use pure FX-driven returns, i.e. log exchange rate changes. The convention matches that of the
previous section, so that a positive return corresponds to an appreciation.
26
In practice, these portfolios are moderately stable but not constant: currencies typically remain in their
most common portfolio throughout 68% of the sample, based on an average across risk factors.
4.2 Risk Factors and Global Financial Conditions
After computing portfolio returns as described in Sect. 4.1, we proceed to analyse

how their distributions are affected (in sample) by shifts in global financial condi-
tions, as in Sect. 3. In line with the previous section, we first estimate conditional
quantile functions for each portfolio returns series, and then fit two empirical distri-
butions: one conditional on average global financial conditions, and another condi-
tional on a one standard deviation tightening of global financial conditions. That is,
we want to know the distribution of returns of each portfolio under both ‘normal’
and ‘tight’ global financial conditions. If a factor under consideration is indeed a
‘true’ risk factor, we would expect the return of the riskier portfolio to skew more
significantly to the left following a tightening of global financial conditions (that is,
we would expect a larger increase in the likelihood of currencies exposed to that fac-
tor depreciating sharply in the event of a global shock).
Figure 7 provides an example by reporting distributions of high- and low-risk
portfolios (in red and blue, respectively) sorted on the basis of interest rate differ-
entials vis-à-vis the rest of the world, both conditional on average (solid lines) and
‘tight’ global financial conditions (dashed lines).27 Two features stand out. First,
under average global conditions, the returns of the high-risk portfolio already exhibit
‘fatter’ tails than those of the low-risk one. Moreover, with tighter global financial
conditions, the left tail of the distribution of returns of the high-risk portfolio (in
other words, its crash risk) increases sharply, while that of the low-risk portfolio
remains largely unchanged. This behaviour suggest that interest rate differentials are
indeed a risk factor in the face of tighter global financial conditions, in the sense that
they are associated with larger increase in crash risk under such circumstances.
While these directional insights are interesting in their own right, the main advan-
tage of our methodology is that it allows to quantify such tails risks. We therefore
estimate conditional distributions for the returns of portfolios sorted on the basis of
all risk factors we consider, and use them to assess the probabilities of a range of
possible outcomes under different scenarios for global financial conditions. A tangi-
ble output of this exercise is a simple tabular mapping between changes in exposures
to the candidate risk factors and the implied changes in tail risks following a tighten-
ing of global financial conditions within our sample.28
Table 5 reports our results. The first observation is that under average global
financial conditions, riskier portfolios—as sorted by the candidate risk factors—
display negligible crash risk (defined as the probability of losses exceeding 2.5%)
in all cases (col. IV). However, this changes once we condition on tighter global
financial conditions. In such a situation, high-risk portfolios sorted on the basis of
interest rate differentials, level of international reserves and fiscal balances display
significantly higher crash risk than their low-risk alternatives. In contrast, crash risk
27
Analogous figures for the remaining risk factors can be found in Sect. 3 of the Online Appendix.
28
In particular, we consider global financial conditions three standard deviations above their average
level. This compares with prints of 6.6 in October 2008 during the global financial crisis, and 3.7 in
March 2020, at the height of COVID-19-related stress.
1.2
Low risk (average)
Low risk (shock)
1 High risk (average)
High risk (shock)
0.8
Probability density
0.6
0.4
0.2
0
-6 -4 -2 0 2 4 6
Portfolio return (%)
Fig. 7 Return distributions of portfolios sorted by interest rate differentials. Note The figure shows non-
parametric probability densities estimated for the returns of low- (in blue) and high- risk portfolios (in
red) sorted on the basis of interest rate differentials under average global financial conditions (’average’,
solid lines) and global financial conditions one standard deviation tighter than average (’shock’, dashed
lines). (Color figure online)
increases by similar amounts for high- and low-risk portfolios sorted on the basis of
current account balances or net foreign asset positions. Thus overall, only a subset of
the risk factors is positively correlated with ‘crash risk’ in the face of a tightening in
global financial conditions.
This exercise also allows to construct an in-sample mapping from changes in risk
factors to exchange rate crash risk in the event of tighter global financial conditions.
For example, a country whose interest rate differential with respect to the rest of the
world increases by 8.2 p.p. (therefore moving from the middle-risk portfolio to the
high-risk one based on averages over our sample, see col. III) should see an increase
in the probability of its currency depreciating by more than 2.5% of approximately
25 p.p. in the event of a sharp tightening of global financial conditions.29
These findings are consistent with (yet more nuanced than) the mean-based
results in Brunnermeier et al. (2009), Lustig et al. (2011), Menkhoff et al. (2012),
Della-Corte et al. (2016), Fratzscher (2009) and Habib and Stracca (2012). More
precisely, our results show that currencies of countries displaying large values for
29
Strictly speaking, this increase in interest rate differential delivers, on average over the sample, a move
from the average position in the middle-risk portfolio to the average position in the high-risk portfolio,
while of course a smaller change might already lead to a portfolio change with the consequent increase in
crash risk (e.g. if starting from a higher differential within the medium-risk portfolio and moving to the
lower end of the high-risk portfolio).
Table 5 Crash risk probabilities of portfolios under two scenarios for financial conditions
(I) (II) (III) (IV) (V)
Risk factor Portfolio Av. risk factor (%) Crash risk Crash risk
(average, %) (shock, %)
Interest rates H 6.5 1.2 26.6

M –1.7 0.0 0.2
L –4.3 0.0 0.0
Reserves H 3.5 2.6 25.5
M 8.4 0.0 9.0
L 21.1 0.0 0.0
Fiscal H –5.3 0.0 9.2
M –2.0 0.0 5.2
L 2.4 0.0 1.6
CA H –4.3 0.0 13.2
M –0.6 0.0 21.8
L 5.1 0.0 13.6
NFA H –64.1 0.4 22.8
M –17.1 0.0 14.7
L 54.5 0.0 25.0
The table shows the probabilities of returns losses greater than 2.5% (‘crash risk’) for high-, medium-
and low-risk portfolios as sorted by the range of risk factors listed in col. I, both under average global
financial conditions (col. IV) and global financial conditions three standard deviations tighter than aver-
age (col. V). The average value of the risk factor for the currencies comprising each portfolio is also
reported (col. III). The table allows to compute, for each risk factor, the (average) required change in the
risk factor for a currency to switch between the H, M and L portfolios, and the implied change in crash
risk under alternative scenarios for financial conditions
the risk factors considered not only experience a reduction in their conditional mean
in the face of tighter global conditions, but the resulting distributions change shape,
with a more than proportional increase in the probability mass assigned to the left
(depreciation) tails for some of the risk factors.
In sum, in this section we showed that a number of intuitive risk factors contain
useful information for quantifying exchange rate risk in the face of tighter global
financial conditions. These insights should be of interest to policymakers assessing
the financial stability outlook of countries, and to investors performing risk manage-
ment calculations for their investment strategies, which naturally rely on tail risk
information.
5 Robustness
In this section we list a series of robustness checks on our baseline results along
four dimensions. First, we show that richer specifications of the conditional quan-
tile function do not alter our key results. Second, we study alternative exchange rate
measures, namely US dollar bilaterals and currencies’ excess returns (net of interest
rate differentials). Third, we modify our exercise in Sect. 4 by sorting portfolios

using lagged values of the sorting variables to rule out reverse causality issues. And
finally, we consider a range of alternative proxy measures for global financial condi-
tions. All results are available in Sect. 4 of the Online Appendix.
5.1 Specification of the Quantile Function
Our baseline specification, shown in Eq. 1, is deliberately parsimonious. In this

section we explore the consequences of more complex specifications along three
dimensions: a generic control for omitted variables by means of a lagged FX returns
term; a control for ‘standard’ factors typically found to be relevant for FX returns;
and a control for possible nonlinear effects in the quantile function itself.
A straightforward way of checking whether the specification suffers from an obvi-
ous omitted variables problem is to add lagged exchange rate returns to the explana-
tory variables. The resulting specification then becomes a quantile autoregression
(Koenker et al. 2006), with an added exogenous regressor. The resulting estimates of
𝛽h (𝜏) (that is, the coefficient corresponding to our global financial conditions index)
are usually very similar to the baseline. Charts can be found in Sect. 4.1.1 of the
Online Appendix.
In a separate exercise, we augment our specification by adding ‘standard’ factors
used to account for the factor structure usually found in exchange rate returns. Spe-
cifically, we include a ‘dollar’ factor, which is the average return across portfolios
of interest rate-sorted US dollar bilateral exchange rates, and a ‘carry’ factor, which
computes the return of going ‘long’ on the portfolio of currencies with the highest
interest rate differentials (vis-à-vis the US), and ‘short’ on the portfolio of currencies
with the lowest interest rate differentials. Data for the returns of both factors comes
from Lustig et al. (2011). We find that while these two additional factors tend to be
significant in explaining the returns of the currencies in our sample (as expected),
they do typically leave the coefficient corresponding to our global financial condi-
tions index broadly unchanged, which suggests that they contain different informa-
tion. Charts can be found in Sect. 4.1.2 of the Online Appendix.
Finally, we also explore the potential role of nonlinearities in the quantile func-
tion itself by considering an additional quadratic term for our global financial condi-
tions index.30 We find that the coefficient corresponding to this additional term is
usually small and typically non-significant for most of the currencies in our sample.
Moreover, the coefficients are also typically constant across quantiles, which there-
fore results in small parallel shifts in the coefficient on the linear term, which nev-
ertheless maintains its ‘shape’ across quantiles (and its significance). Charts can be
found in Sect. 4.1.3 of the Online Appendix.
30
As opposed to the nonlinear relationship between the dependent variable and the regressors that is
already inherent in the quantile regression approach.
5.2 Alternative Measures of Exchange Rate Returns
Our baseline results in Sect. 3 are based on nominal effective exchange rates
(NEERs). This choice is motivated by the desire to focus on plain exchange rate
moves, abstracting from interest rate differentials, and to avoid US-driven, glob-
ally synchronised changes in bilateral dollar exchange rates. However, in order to
facilitate comparisons with the existing literature, we also report results of exer-
cises that consider alternative choices: NEERs-based excess returns and US dol-
lar bilaterals. Charts showing downside and upside entropies for comparison with
our baseline results can be found in Sect. 4.2 of the Online Appendix.
Results are broadly unchanged when considering excess returns, which net out
interest rate differentials of the currency under consideration vis-à-vis the rest
of the world. For US dollar bilaterals the changes are also small. Tail behaviour
rankings based on relative entropy are virtually unaltered, despite changes in their
values in the expected direction: given the high conditional upside entropy of the
US dollar NEER itself, the conditional upside entropies of other safe haven cur-
rencies become smaller when considering dollar bilaterals, while the downside
entropies of risky currencies increase.
5.3 Portfolio Sorting Strategy
In our baseline results, the sorting of currencies into portfolios based on the val-
ues of risk factors is done based on contemporaneous values of the risk factors.
More specifically, the sorting is done at annual frequency due to data availability,
while the conditional returns of the resulting portfolios are measured at monthly
frequency. One downside of such strategy is that it is liable to suffering from
reverse causality, because the risk factors could themselves change in response
to changes in global financial conditions over the year, in turn affecting the com-
position of portfolios. A solution is to perform the portfolio sorting using lagged
values of the risk factors, which comes at the cost of potentially using out-of-
date data, given the annual rebalancing of portfolios but monthly returns compu-
tation. With this caveat in mind, we check the robustness of the results reported
in Sect. 4 to this alternative sorting strategy, and find that our results, reported in
Sect. 4.3 of the Online Appendix, are broadly unchanged.
5.4 Measurement of Global Financial Conditions
Our global financial conditions index is one of many attempts in the literature to
summarise moves in global risky asset prices. Other available measures put for-
ward include the global factor presented in Miranda-Agrippino and Rey (2015)
(MAR), the RORO index introduced by Chari et al. (2020) and the index intro-
duced by Bekaert et al. (forthcoming) (BEX). Moreover, the VIX index, despite
being specific to the US stock market, has been used as yet another gauge of
global risk (see, for example, Habib and Stracca (2012), who identify their global
risk shock based on VIX data).
In this section we compare the goodness of fit achieved by the global indices
listed above when trying to fit variation in the tail regions of the distributions of
returns of the currencies in our sample (as in Table 3 for our baseline results). To
streamline the exposition, we focus on the average R1 across tail quantiles achieved
by each index for the tail region that it fits best for each currency considered.31 We
first compare specifications which consider each index in turn, benchmarking them
against our baseline specification (with our GFCI index alone) over a common
sample. We subsequently consider a specification which includes several indices
jointly.32
The pairwise comparisons in columns (1) to (8) of Table 6 show that, apart from
the Miranda-Agrippino and Rey (2015) index, which seems to have a somewhat
lower explanatory power for FX returns, the rest of the measures deliver broadly
similar results. Our GFCI index typically delivers higher R1 measures than the
RORO and BEX indices, while the comparison with the VIX index (cols. 1-2) is
more nuanced, as the VIX delivers a higher R1 for the aggregate sample, but per-
forms worse when the comparison is restricted to EMs. The latter result is not sur-
prising given the global nature of our index and the US-specific nature of the VIX.
The specification that adds the VIX, RORO and BEX indices jointly with our
GFCI (col. 10) fares better than a GFCI-only alternative over the same sample (col.
9), which suggest that, despite sharing a strong common component (as seen in the
high correlations documented in Table 2 and also suggested by the first eight col-
umns of Table 6), there is a degree of complementary information contained in them
that can be exploited for fitting exchange rate tail risk even better.
6 Conclusion
We provide novel empirical evidence on the relationship between the entire distri-
bution of currency returns and global financial conditions. Our results corroborate
some of the prevailing narratives about safe haven and risky currencies, but also
provide richer insights than existing studies focussing on mean returns, allowing
for example to rank currencies according to their tail behaviour and to quantify the
shifts in their distributions following changes in global financial conditions. We
also document the role of commonly used macro-financial risk factors in explain-
ing losses on FX portfolios in the face of tighter global financial conditions. These
insights should be of interest to policymakers assessing the financial stability out-
look of countries, and to investors performing risk management calculations for
their investment strategies.
31
Specifically, we report the highest of the two average R1s between percentiles 5 to 25 and 75 to 95,
respectively.
32
We exclude the MAR index for this exercise given that it ends early in our sample and would therefore
have resulted in a significant loss of observations.
Table 6 Goodness of fit measure for ‘best’ tail

VIX MAR RORO BEX ALL
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Australia 7.8 6.0 10.0 0.4 8.2 5.8 7.8 6.4 8.2 15.3
Japan 8.6 15.1 8.3 0.7 14.5 5.0 8.6 10.0 14.5 22.4
Euro area 4.0 4.3 3.4 0.5 1.1 2.4 4.0 3.8 1.1 3.9
Switzerland 5.8 6.3 6.7 0.6 5.3 0.2 5.8 3.6 5.3 10.9
UK 3.4 4.2 6.4 0.9 5.2 9.5 3.4 4.7 5.2 10.1
US 4.5 5.2 9.5 1.2 6.7 2.5 4.5 5.4 6.7 11.8
Full sample 4.0 4.4 4.5 1.6 4.6 3.1 4.0 3.7 4.6 8.2
Liquid EMs 5.2 5.1 6.4 1.8 6.9 2.9 5.2 5.0 6.9 10.7
BRICS 5.2 4.3 6.7 2.4 6.5 3.2 5.2 4.5 6.5 10.7
The table shows goodness of fit measures for the most accurately fitted tail in each case. This is com-
puted as the highest of the average R1 (𝜏) between the 5th and 25th percentiles for the left tail, and between
the 75th and 95th percentiles for the right tail. ‘Full sample’ refers to the average of this measure across
the 61 currencies in our sample, ‘Liquid EMs’ to the average measure for the currencies of China, Hong
Kong, Korea, Singapore, Mexico, India, Russia, South Africa, Turkey and Brazil (which were the ten
most traded EM currencies in 2019 according to Schrimpf and Sushko 2019) and ‘BRICS’ to the average
measure for the currencies of Brazil, Russia, India, China and South Africa. Each block of two columns
compares a specification which includes our GFCI alone first, and a specification that contains an alter-
native index alone in the second place, for the same sample. GFCI refers to our Global Financial Condi-
tions Index, VIX to the VIX index, MAR to the index from Miranda-Agrippino and Rey (2015), RORO
to the index from Chari et al. (2020) and BEX to the index in Bekaert et al. (forthcoming). ALL refers to
a specification that includes the VIX, the RORO and BEX indices, as well as our GFCI
Appendix: Data
Definitions and Sources
See Table 7 for definition of variables and data sources.

Table 7 Variable definitions and data sources
Variable Definition Source
ΔFXi,t Monthly change in the broad nominal effective exchange rate. BIS
GFCIt Global financial conditions index (see below for underlying Authors’ calculation
components)
GFCI components
Long-term gov. interest rate Yield on nominal government bonds with maturity of 10 years. Thomson Reuters Datastream
Sovereign spreads Advanced economies: difference between domestic long-term Thomson Reuters Datastream
government interest rates and those of bonds of a benchmark
country (Germany for Europe and US for rest of the world).
Emerging market economies: stripped spreads from JP Mor- JP Morgan
gan’s EMBI.
Term spreads Difference between domestic long-term government interest Thomson Reuters Datastream and Bank of America Merrill
rates and a domestic short term T-bill rate (with maturity of Lynch.
3 months or closest).
Attention to the Tail(s): Global Financial Conditions and…
Interbank spreads Difference between 3-month interbank rate (or closest) and Thomson Reuters Datastream and national central banks.
3-month T-Bill rate (or closest).
Corporate spreads Corporate spread indices. Bank of America Merril Lynch, Barclays, JPMorgan (CEMBI)
and Standard & Poor’s.
Equity returns 3-month return of domestic stock index, measured in domestic Thomson Reuters Datastream
currency.
Equity volatility Realised monthly volatility computed using daily changes in Thomson Reuters Datastream
equity index.
Market capitalisation of financial sector Market capitalisation of MSCI Country Financials Index MSCI Inc.
divided by MSCI Country Index.
Risk factors
Forward discount Forward discount of currency relative to the rest of the curren- Thomson Reuters Datastream
cies in our sample. Bilateral forward discounts obtained as
the percentage difference between the spot exchange rate and
a 3-month exchange rate forward contract.
513
Reserves Total international reserves of country as a share of GDP. IMF IFS

Table 7 (continued)
514
Variable Definition Source
Fiscal balance Fiscal position of the government after accounting for capital OECD
expenditures as a share of GDP.
Current account Current account balance as a share of GDP. IMF IFS and OECD
Net foreign assets Net international investment position (claims on non residents IMF IIP/BOP interpolated with Lane and Milesi-Ferretti (2018)
minus liabilities to them). when missing
F. Eguren‑Martin, A. Sokol
Samples
Exchange rates. The analysis in Sect. 3 is conducted using Nominal Effective

Exchange Rates (NEERs) from the BIS from January 1994 to June 2018 for the
following countries: Algeria, Argentina, Australia, Austria, Belgium, Brazil, Bul-
garia, Canada, Chile, China, Chinese Taipei, Colombia, Croatia, Cyprus, Czech
Republic, Denmark, Estonia, Euro area, Finland, France, Germany, Greece, Hong
Kong, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Japan, Korea,
Latvia, Lithuania, Luxembourg, Malaysia, Malta, Mexico, Netherlands, New Zea-
land, Norway, Peru, Philippines, Poland, Portugal, Romania, Russia, Saudi Ara-
bia, Singapore, Slovakia, Slovenia, South Africa, Spain, Sweden, Switzerland,
Thailand, Turkey, United Arab Emirates, United Kingdom, United States and
Venezuela.
Exchange rate changes are computed as log differences on monthly averages; inter-
est rate differentials (and the corresponding excess returns) are not considered in the
baseline analysis.
Financial condition indices. We compute FCIs at the monthly frequency from
April 1995 to June 2018 for the following countries: Argentina, Australia, Austria,
Belgium, Brazil, Bulgaria, Canada, Chile, China, Colombia, Czech Republic, Den-
mark, Finland, France, Germany, Hungary, India, Ireland, Israel, Italy, Japan, Korea,
Malaysia, Mexico, Netherlands, New Zealand, Norway, Peru, Philippines, Poland,
Portugal, Russia, South Africa, Spain, Sweden, Switzerland, Thailand, Turkey,
United Kingdom, United States and Venezuela.
Armed with a set of country-specific FCIs we then compute our proxy of global
financial conditions as the first principal component of these.
Appendix: Quantile Regression
Given a linear model for the conditional quantile function

Qy (𝜏|X) = x𝛽(𝜏) (B.1)
̂ is the minimiser of
the quantile regression estimate 𝛽(𝜏)
∑ ( )
̂
V(𝜏) = minp 𝜌𝜏 yi − xi� 𝛽 (B.2)
𝛽∈ℝ
where 𝜌𝜏 (u) = u[𝜏 − I(u < 0)] is the so-called check function.
As discussed in Koenker (2005), the solution of problem B.2 is amenable to lin-
ear programming techniques. However, in our MATLAB implementation, we have
found it computationally more efficient to approximate the exact solution via an iter-
atively-reweighted-least-squares (IRLS) algorithm. This is motivated by the close
relationship of B.2 to the problem of finding the least-absolute-deviations (LAD)
estimator (which obtains for 𝜏 = 0.5), and more generally of solving Lp −norm linear
regression problems. Building on Mohammadi (2009), we proceed as follows: we
start from an initial OLS estimate,
( )−1
𝛽̂(0) (𝜏) = x� x x� y.
We then take the residuals ûi (0) (𝜏) = yi − xi 𝛽̂(0) (𝜏) and construct a diagonal matrix of
weights w(t) , t > 0, whose diagonal elements are given by
1
w(t)
ii
(𝜏) = ( )
𝜌1−𝜏 u(t−1)
i
(𝜏)
We then obtain an updated estimate 𝛽̂(t) (𝜏), residuals û (t) (𝜏) and weights w(t+1) (𝜏)
using weighted least squares:
( )−1
𝛽̂(t) (𝜏) = x� w(t) (𝜏)� x x� w(t) (𝜏)� y
and iterate until convergence. Essentially, the procedure approximates B.2 by a con-
vergent sequence of weighted sums of square residuals, where the weights are cho-
sen so as to approximate the check function 𝜌𝜏 with a quadratic one.
Bootstrapping
While there are several results available for inference in quantile regression with
time-series data (see for example Xiao (2012), Zhou and Shao (2013)), we take a
shortcut and deal with potential autocorrelation in the errors from B.2 by bootstrap-
ping confidence intervals for all quantities of interest. Fitzenberger (1998) shows
that a moving (or overlapping) block bootstrap procedure provides heteroskedastic-
ity- and autocorrelation-consistent (HAC) standard errors for quantile regression
coefficient estimators.
The procedure works as follows: letting zt = [yt , xt ] denote the original data,
T the sample size and b a suitably chosen block length, a resample z∗it of length
T ∗ = b ∗ round(T∕b) is obtained by joining round(T/b) draws (with replacement) of
b consecutive elements of zt (blocks), where the blocks are allowed to overlap. Each
resample z∗it yields an estimate of the quantile regression coefficients 𝛽̂i∗ (𝜏) and can
be used to compute all other statistics of interest, such as V̂ i (𝜏) and thus R1 (𝜏) etc.
Confidence intervals at level 𝛾 for 𝛽(𝜏)
̂ and other quantities of interest are computed
as
( )
̂ − 𝛽̂∗1−𝛾 (𝜏), 2𝛽(𝜏)
2𝛽(𝜏) ̂ − 𝛽̂∗𝛾 (𝜏) (B.3)
2 2
where 𝛽̂p∗ (𝜏) denotes the p−th percentile of the bootstrapped draws 𝛽̂i∗ (𝜏)33.
33
In the computation of confidence intervals for R1 (𝜏) we instead compute directly percentiles from the
bootstrapped draws to ensure non-negative values.
Fitting a Nonparametric Distribution to the Quantiles
We seek to match the fitted quantiles implied by the model in Eq. 1, q̂ (𝜏), condi-
tional on average global financial conditions (which are 0 by construction), given
simply by q̂ GFC=0 (𝜏) = 𝛼̂ h (𝜏), and conditional on a one standard deviation increase
in global financial conditions, given by q̂ GFC=1 (𝜏) = 𝛼̂ h (𝜏) + 𝛽̂h (𝜏), with the quan-
tiles of nonparametric distributions with Normal kernel 𝜙 and suitably chosen band-
width h, whose generic density function is given by:
I (x − z )
1 ∑ i
fh (x) = 𝜙 . (B.4)
Ih i=1 h
This is accomplished by solving the following minimisation problem for the two sets
of fitted quantiles q̂ (𝜏):
∑[ ]2
minI q̂ (𝜏) − Qh (𝜏|{zi }I1 ) (B.5)
{zi }1 𝜏
where Qh (𝜏|{zi }I1 ) is the 𝜏 -th quantile function of fh (x), which depends on a set of I
artificial observations zi that are chosen so as to match the fitted quantiles.
Supplementary Information The online version contains supplementary material available at https://doi.
org/10.1057/s41308-022-00160-0.
Acknowledgements Work on this project started when both authors were staffmembers of the Bank of
England. Over part of the project, AndrejSokol was also a staff member of the European Central Bank.
We wouldlike to thank Gino Cenedese, Georgios Georgiadis, Simon Lloyd,Daniele Massacci, Angelo
Ranaldo, Barbara Rossi, Lucio Sarno, AndresSchneider, Livio Stracca, Giorgio Valente, Nancy Xu
(discussant),seminar participants at Oxford University, the Bank of England andthe European Central
Bank, and conference participants at IAAE 2019,MMF 2019 and EFA 2020 for useful comments and
discussions. The viewsexpressed in this paper are solely those of the authors and shouldnot be taken to
represent those of the Bank of England, the EuropeanCentral Bank or SPX Capital.
Declarations
Conflict of interest The authors declare that they have no conflict of interest.
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Publisher’s Note Springer Nature remains neutral with regard to jurisdictional claims in published
maps and institutional affiliations.
Fernando Eguren‑Martin is a Global Economist at SPX Capital. Previously, he was Senior Research
Economist at the Bank of England. His research interests include international macroeconomics and
finance, and his work on these fields has been published in leading academic journals and received media
attention, including by Bloomberg and The Wall Street Journal. He holds a DPhil (PhD) in Economics
from Oxford University (Mansfield College), a Masters in Economics and Finance from CEMFI and a
BSc in Economics from UTDT.
Andrej Sokol has held various Economist positions at the Bank of England and the European Central
Bank. His research interests include monetary and macroprudential policy, international macro and
finance, applied macro, econometrics, and forecasting. He holds an MSc in Economics from Queen Mary
University of London and MSc and BSc degrees in Management Engineering from Politecnico di Milano.

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IMF Economic Review (2022) 70:487–519

Attention to the Tail(s): Global Financial Conditions

Fernando Eguren‑Martin1,2 · Andrej Sokol2

Published online: 24 March 2022

Keywords Exchange rates · Tail risks · Financial conditions indices · Global

JEL Classification C22 · F31 · G15

Japanese yen (JPY) is typically regarded as a ‘safe haven’ currency as it tends to

(a) Japan (b) Australia

2 Measuring Global Financial Conditions

Armed with a set country-specific financial condition indices, we then compute a

3 Assessing Exchange Rate Tail Risks with Quantile Regression

As discussed in Sect. 2, asset prices tend to display a high degree of co-movement

Following the (limited) existing literature applying quantile regression to exchange

(a) Time series (b) Histogram

Table 1 Higher moments of GFCI VIX MAR RORO BEX

Australia Japan Euro area

Switzerland United Kingdom United States

We estimate Eq. (1) on a currency-by-currency basis for a panel of 61 countries

Quantile-specific measures of goodness of fit represent a distinctive advantage of

3.3 Summary Measures of Tail Behaviour

The information conveyed by quantile-specific coefficients estimates can also be

Table 3 Goodness of fit

Australia 16.2 2.5 –0.2 –0.3 1.3 4.1

The table shows quantile-specific goodness of fit measures R1 (𝜏)

Australia Japan Euro area

Switzerland United Kingdom United States

Australia 3.3 4.9 –5.6 –4.4 1.4 0.3

3.4 An Application to the COVID‑19 Crisis

4 Identifying Risk Factors: A Portfolio Sorting Approach

(a) Japan (b) Australia

Identifying country characteristics associated with the individual features of

4.2 Risk Factors and Global Financial Conditions

After computing portfolio returns as described in Sect. 4.1, we proceed to analyse

Interest rates H 6.5 1.2 26.6

rate differentials). Third, we modify our exercise in Sect. 4 by sorting portfolios

5.1 Specification of the Quantile Function

Our baseline specification, shown in Eq. 1, is deliberately parsimonious. In this

5.2 Alternative Measures of Exchange Rate Returns

5.3 Portfolio Sorting Strategy

5.4 Measurement of Global Financial Conditions

Table 6 Goodness of fit measure for ‘best’ tail

Definitions and Sources

See Table 7 for definition of variables and data sources.

Reserves Total international reserves of country as a share of GDP. IMF IFS

Variable Definition Source

Exchange rates. The analysis in Sect. 3 is conducted using Nominal Effective

Appendix: Quantile Regression

Given a linear model for the conditional quantile function

Fitting a Nonparametric Distribution to the Quantiles

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2 Measuring Global Financial Conditions

3 Assessing Exchange Rate Tail Risks with Quantile Regression

3.3 Summary Measures of Tail Behaviour

3.4 An Application to the COVID‑19 Crisis

4 Identifying Risk Factors: A Portfolio Sorting Approach

4.2 Risk Factors and Global Financial Conditions

5.1 Specification of the Quantile Function

5.2 Alternative Measures of Exchange Rate Returns

5.3 Portfolio Sorting Strategy

5.4 Measurement of Global Financial Conditions