Authors: Tobias Adrian, Erkko Etula, and Hyun Song Shin

We present evidence that fluctuations in the aggregate balance sheets of financial intermediaries forecast exchange rate returns—at weekly, monthly, and quarterly frequencies, both in and out of sample, and for a large set of countries. We estimate prices of risk using a cross-sectional, arbitrage-free asset pricing approach and show that balance sheets forecast exchange rates because of the latter’s association with fluctuations in risk premia. We provide a rationale for an intertemporal equilibrium pricing theory in which intermediaries are subject to balance sheet constraints.