FX Swap Research Articles

FX intervention to stabilize or manipulate the exchange rate? Inference from profitability

We analyze the profitability of FX swaps used by the central bank of Brazil to shed light on the rationale for FX intervention. We find that swaps are profitable from an ex-ante perspective, suggesting that FX intervention is used to stabilize the exchange rate against temporary excessive fluctuations relative to UIP conditions. Consistent with this interpretation, we document that the direction and size of FX intervention responds to UIP deviations. We also find that FX intervention responds more aggressively to UIP deviations when there is less uncertainty about the future level of the exchange rate and when the exchange rate is overvalued.

FX swaps and forwards in global dollar debt: “Known knowns” and “known unknowns”

Several types of FX derivatives involve the exchange of principal, making them a form of collateralised loan. But unlike other forms of collateralised borrowing, the payment obligations associated with such derivatives are not reported on the balance sheet: they are in a very real sense “missing debt”. This introduces gaps in the compilation of countries’ and sectors’ foreign currency positions, in particular their short-term US dollar obligations and receipts. When economic shocks occur, policies designed to restore the flow of dollar liquidity outside the United States (eg central bank swap lines) are blind to the scale of dollar liquidity needs in particular locations. This paper presents evidence that the missing dollar debt of banks and non-banks outside the United States is large, roughly double the dollar debt recorded on their balance sheets. It then reviews how well benchmark statistical collections – BIS international banking statistics (IBS), BIS OTC Derivatives (OTCD) statistics, International Investment Position (IIP) statistics, and the Coordinated Portfolio Investment Survey (CPIS)) – capture foreign currency positions, both on- and off-balance sheet, and where modifications to these statistics could help to close data gaps.

Price-setting in the foreign exchange swap market: Evidence from order flow

Using transaction level data from the inter-dealer market, we find that the price impact of one standard deviation change in FX swap order flow has increased from less than one basis point prior to 2008 to about five basis points after 2008. However, the increase in price impact is confined to periods of elevated dispersion in funding costs and over quarterends. Central bank swap lines reduce the order flow into USD, subsequently affecting the FX forward rate. In contrast, over quarter-ends and after monetary policy announcements we observe that dealers immediately adjust prices to curb order flow.

A Macroeconomic Perspective on Brazilian FX Swaps

This paper takes a macroeconomic perspective on Brazilian foreignexchange swaps. It was found that foreign exchange swap shocks lowerination, ease nancial conditions by reducing the risk premium, areassociated with temporarily higher economic activity and lower interestrates in the medium run. After a swap shock, the impact on theexchange rate is at best short-lived. A counterfactual exchange ratewithout the contribution of swap shocks shows periods when the Realwould be almost 4 percent weaker.

Covered Interest Parity Arbitrage

Abstract To understand deviations from covered interest parity (CIP), it is crucial to account for heterogeneity in funding costs across both banks and currency areas. For most market participants, the no-arbitrage relation holds fairly well when implemented using marginal funding costs and risk-free investment instruments. However, a few high-rated banks do enjoy CIP-arbitrage opportunities. Dealers avert inventory imbalances stemming from lower-rated banks’ usage of FX swaps to obtain dollar funding by inducing opposite (arbitrage) flows from high-rated banks. Arbitrage trades are difficult to scale, however, because funding costs increase as soon as arbitrageurs increase positions. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Hungarian forint FX swap spreads during and beyond crisis times

Incentivised by a wide range of research discussing mispricing in USD related swap markets, the paper aims at discovering the factors contributing to the deviation of the 3-month FX swap points in the EURHUF and USDHUF market from their CIP based values primarily between the period January 2008 and December 2018 and with an extension to the end of 2021 using daily and monthly Bloomberg quotes. The period examined can be divided into three plus one subperiods as concerns FX swap spreads, largely determined by the effects of the global financial crisis and the volume of FX loans. Apart from the most important classes of variables explaining FX swap spreads, counterparty, funding and market liquidity risk indicators, the literature identifies, policy variables were also involved in the analysis. During and in the aftermath of the 2008 global financial crisis, the MNB applied various kinds of FX swap tenders to ease FX liquidity tensions in the Hungarian interbank market, and continued providing such operations even after the conversion of household FX loans to domestic currency. The results of VARX estimations suggest that indicators of market and liquidity tension, counterparty risk mostly positively contributed to the widening of FX swap spreads, in addition, policy intervention had a spread dampening impact throughout most of the period. The paper confirms that central bank FX swap market participation can mitigate mispricing especially in turbulent times.

Home Bias of Korean Resident Bond Investors: The Role of FX Hedging

ABSTRACT This paper analyzes the home bias of Korean resident bond investors, as their overseas bond investments have rapidly increased after 2000. For this purpose, we introduce the Won/invested currency swap basis (interest rate differential adjusted FX swap return) and the Won/invested currency uncovered basis (interest rate differential adjusted expected FX spot return) along with the interest rate gap based on CIP and UCIP respectively in order to address the return factors in detail. The model coefficients are estimated by the static pooled OLS and the dynamic system GMM over the period of 2002–2018 and 2009–2018 respectively. With these estimation results, we have obtained the following implications. First, it is expected that the level of home bias will decline as Korean resident overseas bond investments increase, as the factors that have traditionally caused home bias continue to mitigate. Second, when Korean residents invest in overseas bond markets, the FX risk has partially hedged at the country level. This suggests that the rapid in/out flows for overseas bond transactions make a significant impact on the FX swap rates as well as spot rates. Third, both groups of investors have taken into heavy consideration both the FX swap basis (or the FX uncovered basis) related to the invested currency/USD as well as to Won/USD. Our findings suggest that the policy makers need to reconsider their conventional monitoring methods which are focused on the Won/USD transactions.

Effectiveness of Central Bank Swap Lines in Alleviating the Mispricing of FX Swaps at the Start of the Covid-19 Pandemic

Effectiveness of Central Bank Swap Lines in Alleviating the Mispricing of FX Swaps at the Start of the Covid-19 Pandemic

FX Swap Valuation As a Cost of Filling Dollar Funding Gap: A Hierarchical and Dealer-Centric Perspective

This paper constructs a model of the FX swap valuation, the cost of synthetic dollar borrowing, based on the dealers’ behavior and the hierarchy of international finance. In this model, three fundamentals- market-making costs (measured by dealers’ bid-ask spreads), dollar funding liquidity risk (measured by CIP deviation), and the FX swap market liquidity (measured by the dealers’ competition)- derive the valuation of FX swap. The goal is to understand the financial instability spillovers between FX swaps and offshore US-Dollar funding markets through the “dealers” channel. FX dealers are vital institutions that connect different national monetary jurisdictions in the international monetary system. For currencies where FX turnover is low, market makers are central banks. On the other hand, those dealers are primarily private banks for currencies with the highest FX turnover, such as the US dollar. Nevertheless, studying the “dollar funding gap” through the lens of FX swap dealers is a feature that often gets overlooked in International Political Economy scholarship.

Countercyclical Foreign Currency Borrowing: Eurozone Firms in 2007–09

AbstractUsing syndicated loan‐level data, we document and explain the causes and implications of a new and surprising stylized fact. In the midst of the financial crisis, dollar borrowing by leveraged Eurozone (EZ) corporates rose dramatically relative to their euro borrowing. We show that this resulted from a shift from EZ to non‐EZ banks, mainly U.S. banks. This was combined with an increase in the proportion of dollar lending by non‐EZ banks, explained by a rise in the relative cost of euro wholesale funding and the disruptions in the FX swap market. Non‐EZ banks thus dampened the 2007–09 credit crunch in Europe.

The Impact of Margin Requirements on Voluntary Clearing Decisions

We analyze the determinants of financial entities’ choices of whether to voluntarily designate trades for central clearing. In particular, we evaluate the impact of the Uncleared Margin Rule (UMR) on the trading and clearing decisions of firms transacting in the multi-trillion-dollar cash-settled foreign exchange swap markets. The UMR is a multi-jurisdiction rule that requires certain market participants to exchange collateral (margin) for uncleared transactions between themselves. We specifically study the effect of this rule for non-deliverable forwards (NDF) since similar contracts – FX deliverable forwards and swaps - are exempt from the rule in the U.S. and hence constitute a useful control group. In a difference-in-differences setting, we find that compared to FX forwards and swaps, the UMR resulted in firms choosing to clear a higher percentage of their swaps in the NDF market. To understand the forces behind firms’ clearing decisions, we make use of a regulatory data set that includes the identities of the parties to each swap. We show that increased clearing is due almost exclusively to the actions of clearing members, suggesting that the differential cost of clearing for these entities plays a major role in clearing decisions. Consistent with theory, we find the ability to net swap exposure at the central clearing party is one of the drivers behind the decision to clear.

The Calming of Short-Term Market Fears and Its Long-Term Consequences: The Federal Reserve's Reaction to COVID-19

We study the impact of five key Fed policy responses to the Covid-19 crisis on the stock market's fear of loss and fear of variability. Using a unique global dataset of option prices to construct the term structures of fear, up to ten years into the future, we find that FX swap lines have the most decisive impact on market fear, but only on the US and countries with access to the swaps. Liquidity support and macroprudential policies had a smaller but still significant impact, while policies aimed to support the wider economy did not affect fear. These results raise important questions on the trade-off between short-term market calming and long-term moral hazard, as well as the relative importance of central banks, and the importance of the Federal Reserve as a global liquidity provider.

FX Intervention to Stabilize or Manipulate the Exchange Rate? Inference from Profitability

We analyze the profitability of FX swaps used by the central bank of Brazil to shed light on the rationale for FX intervention. We find that swaps are profitable in expectation, suggesting that FX intervention is used to stabilize the exchange rate in the face of temporary excessive movements rather than to manipulate it away from fundamental values. In line with this interpretation, we find that the scale of FX intervention responds to the degree of exchange rate misalignment relative to UIP conditions. We also document that intervention is more aggressive when there is less uncertainty about the medium-term level of the exchange rate and when the exchange rate is overvalued rather than undervalued.

Hedging-Induced Correlation in Illiquid Markets

I develop a model with two assets in which the hedging activity of derivatives dealers, interacting with market illiquidity, distorts the covariance structure of the market. I apply the model to hedging of counter party risk, and find strong support for the model's key predictions. Using evidence from Japan, I show that hedging of counterparty risk associated with currency swap portfolios drives a strong, non-fundamental correlation between credit and currency markets. The effects are economically significant. For example, I estimate that counter party risk hedging associated with SoftBank's FX swap portfolio accounts for 25% of the weekly volatility of SoftBank CDS returns.

СОВРЕМЕННЫЙ ПОДХОД К ПОВЫШЕНИЮ ДОХОДНОСТИ ИНВЕСТИЦИОННЫХ ПРОЕКТОВ

This research paper describes one of the possible approaches to project management in an uncertain business environment as part of the implementation of operational policy. The operational stage of the project is a key factor in the company's success in the market, as its effectiveness is directly reflected in the company's revenue, financial results, project payback and the ability to use free cash for planned purposes. The scientific research was based on the premise that companies operate in a highly competitive environment, when it is extremely difficult to change operational policies. Such restrictions include the response of competitors, which can be expressed in a price war and increased marketing costs, which forces the company to spend even more financial resources to maintain its presence in the market. In this case, the company can resort to improving financial efficiency by using available resources more efficiently, increasing the return on investment and hedging risks. We considered the optimization option when the company uses a non-standard method of project analysis with such a tool as FX SWAP. The main idea of this method is to obtain additional income from investing Free Cash Flow in a financial asset in a foreign currency, which brings an annual income. When using this method, the income consists of the interest income on the investment asset and the increase in the value of the investment asset in foreign currency as a result of the strengthening of the foreign exchange rate. In the scientific study, it was noted that this tool demonstrates its effectiveness only in the case of a fall in the national currency, resulting in additional income, but thanks to such an improvement in financial policy, it is possible to increase all the key performance indicators of the project and increase the free cash that the company will have as a result of the project.

Dynamic Sensitivities and Initial Margin via Chebyshev Tensors

This paper presents how to use Chebyshev Tensors to compute dynamic sensitivities of financial instruments within a Monte Carlo simulation. Dynamic sensitivities are then used to compute Dynamic Initial Margin as defined by ISDA (SIMM). The technique is benchmarked against the computation of dynamic sensitivities obtained by using pricing functions like the ones found in risk engines. We obtain high accuracy and computational gains for FX swaps and Spread Options.

Analysis of Inter-connectedness and Pro-cyclicality of Korean FX Swap Market before/after Global Financial Crisis: Focusing on Analysis of Network Index

Analysis of Inter-connectedness and Pro-cyclicality of Korean FX Swap Market before/after Global Financial Crisis: Focusing on Analysis of Network Index

Divergent monetary policies and international dollar credit: Evidence from bank‐level data

AbstractThis paper uses a comprehensive and detailed bank‐level data set to study how the divergence of central bank balance sheet policy in the US vis‐à‐vis the euro area and Japan would affect the supply of international US dollar loans by global banks. Our empirical findings support the view that the contractionary effect of US monetary normalization on global dollar liquidity would be offset by an expansionary effect from continued supply of US dollar loans by euro area and Japanese banks. The net effect, however, is crucially dependent on the stability of global foreign exchange markets and investor perceptions of the default risks of global banks. Our findings show that there could be a significant contraction of the supply of international US dollar loans if and when the US monetary normalization coincides with a dislocation of the FX swap market and a rise of bank default risks. Our results are robust to alternative model specifications and different data sets.

FX Funding Shocks and Cross-Border Lending: Fragmentation Matters

This paper provides novel empirical evidence on the effect of dislocations in FX swap markets (‘CIP deviations’) on bank lending. Using balance sheet data from UK banks we show that when the cost of obtaining swap-based funds in a particular foreign currency increases, banks reduce the supply of cross-border credit in that currency. This effect is increasing in the degree of banks’ reliance on swap-based FX funding. Notably, high access to alternative funding sources of (on balance sheet) FX funding shield banks’ cross-border FX lending supply from the described channel, but only if such access occurs via internal capital markets. There is evidence of some degree of substitution from banks outside the UK which are not affected by changes in the cost of accessing dollars or euros synthetically.

Kríza likvidity a finančná nákaza v rokoch 20072009: ponaučenie do budúcnosti

The paper explains modern liquidity crisis and financial contagion from shadow banking system to money market in 2007-2009. Liquidity shock was massive due to high connectivity with the quality of underlying (securitized) assets. Thus, the problem of solvency was main driver of the liquidity crisis on the interbank market. Counterparty risk was transmitted to the money market through various channels: direct or indirect exposition to shadow banking, confidence channel, asset price channel and wholesale funding run. The structure of paper is following: first part analyzes financial market infrastructure of shadow banking, wholesale funding (originate-to-distribute) model and ABCP market; the second one describes financial market turmoil and contagion to the money market. Liquidity crisis strongly hit many segments of the money market: unsecured money market, repo market, FX swap market, Eurodollar market. Liquidity crisis was severe due to strong correlation between counterparty risk and liquidity premium as well between funding and market liquidity. Monitoring of the main causes of the liquidity crisis in his early stages is important for the fast reaction by central banks in terms of collateral quality and quantity of the reserve´s supply.