Pricing Risk Globally: Intermediary Constraints, the Dollar, and the Global Financial Cycle

We study how increased uncertainty about U.S. asset returns affects global asset prices and exchange rates in a two-country model with intermediary balance-sheet constraints. Empirically, uncertainty shocks widen global credit spreads, appreciate the dollar, and increase currency risk premia. In our model, higher uncertainty tightens intermediary constraints and lowers asset prices, reversing the counterfactual asset price increase in frictionless models. Because constraints make net worth especially valuable in bad times, risk premia respond strongly to uncertainty shocks. This interaction allows the model to match the credit spread, currency premium, and dollar responses in the data.