As the recent empirical studies surveyed here illustrate, it is very difficult to demonstrate that the exchange rate risk premium depends (through a portfolio balance channel) on the currency composition of outside assets. The existence of a 'portfolio balance effect' is a necessary condition for sterilized intervention to be a genuinely independent tool of monetary policy. This paper studies U.S./Canada data, and attempts to improve on earlier studies by using higher frequency (weekly) data and by implementing an appropriate instrumental variables technique (2S2SLS). However, we still fail to detect evidence of a portfolio balance effect.
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