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Working Paper
Credit Migration and Covered Interest Rate Parity
This paper examines the connection between deviations in covered interest rate parity and differences in the credit spread of bonds of similar risk but different currency denomination. These two pricing anomalies are highly aligned in both the time series and the cross-section of currencies. The composite of these two pricing deviations ? the corporate basis ? represents the currency-hedged borrowing cost difference between currency regions and explains up to a third of the variation in the aggregate corporate debt issuance flow. I show that arbitrage aimed at exploiting one type of security ...
Report
Risk-Free Rates and Convenience Yields Around the World
We infer risk-free rates from index option prices to estimate safe asset convenience yields in ten G-11 currencies. Countries' convenience yields increase linearly with the level of their interest rates, with U.S. convenience yields being the fifth largest. During financial crises, convenience yields grow, but the difference between U.S. and foreign convenience yields generally does not. Covered interest parity (CIP) deviations using our option-implied rates are roughly the same size between the U.S. and each other country. A model where convenience yields depend on domestic financial ...
Discussion Paper
A Look at Convenience Yields around the World
This post estimates “convenience yields” for government debt in ten of the G11 currencies based on analysis from a recent paper. As in our companion post, we measure convenience yields with option-implied box rate data that is estimated from options traded on the main stock market index in each country. We find that a country’s average convenience yield is closely related to its level of interest rates. In addition, we find that average covered interest parity (CIP) deviations are roughly the same across countries when they are measured with box rates. We rationalize these findings with ...
Working Paper
The Hedging Channel of Exchange Rate Determination
We document the exchange rate hedging channel that connects country-level measures of net external financial imbalances with exchange rates. In times of market distress, countries with large positive external imbalances (e.g. Japan) experience domestic currency appreciation, and crucially, forward exchange rates appreciate relatively more than the spot after adjusting for interest rate differentials. Countries with large negative foreign asset positions experience the opposite currency movements. We present a model demonstrating that exchange rate hedging coupled with intermediary constraints ...
Working Paper
U.S. Banks and Global Liquidity
We characterize how U.S. global systemically important banks (GSIBs) supply short-term dollar liquidity in repo and foreign exchange swap markets in the post-Global Financial Crisis regulatory environment and serve as the "lenders-of-second-to-last-resort". Using daily supervisory bank balance sheet information, we find that U.S. GSIBs modestly increase their dollar liquidity provision in response to dollar funding shortages, particularly at period-ends, when the U.S. Treasury General Account balance increases, and during the balance sheet taper of the Federal Reserve. The increase in the ...
Discussion Paper
Understanding the “Inconvenience” of U.S. Treasury Bonds
The U.S. Treasury market is one of the most liquid financial markets in the world, and Treasury bonds have long been considered a safe haven for global investors. It is often believed that Treasury bonds earn a “convenience yield,” in the sense that investors are willing to accept a lower yield on them compared to other investments with the same cash flows owing to Treasury bonds’ safety and liquidity. However, since the global financial crisis (GFC), long-maturity U.S. Treasury bonds have traded at a yield consistently above the interest rate swap rate of the same maturity. The ...