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Liquidity, Risk Appetite and Exchange Rate Movements During the Financial Crisis of 2007-2009

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Author Info

  • Cho-Hoi Hui

    (Research Department, Hong Kong Monetary Authority)

  • Hans Genberg

    (Research Department, Hong Kong Monetary Authority)

  • Tsz-Kin Chung

    (Research Department, Hong Kong Monetary Authority)

Abstract

Given the deleveraging process in the banking sector, banks were reluctant to lend funds in the interbank market because of uncertainty about their own future need for funds during the financial crisis of 2007 - 2009. Aggregate liquidity then declined. This paper investigates the impact of the market-wide liquidity risk and carry-trade incentives on exchange rate movements. The results suggest that liquidity risk measured by the spread between LIBOR and the overnight index swap rate was a significant factor affecting the exchange-rate movements of the euro, British pound and Swiss franc, while carry trades were important for the Japanese yen, Australian dollar and New Zealand dollar.

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File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP09_11_full.pdf
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Bibliographic Info

Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0911.

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Length: 24 pages
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:hkg:wpaper:0911

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Keywords: Sub-prime crisis; carry trades; liquidity; leverage;

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  1. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, Econometric Society, vol. 59(2), pages 347-70, March.
  2. James McAndrews & Asani Sarkar & Zhenyu Wang, 2008. "The effect of the Term Auction Facility on the London Inter-Bank Offered Rate," Staff Reports, Federal Reserve Bank of New York 335, Federal Reserve Bank of New York.
  3. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
  4. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 19(3), pages 418-437, July.
  5. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers, Society for Economic Dynamics 311, Society for Economic Dynamics.
  6. Joseph E. Gagnon & Alain P. Chaboud, 2007. "What can the data tell us about carry trades in Japanese yen?," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 899, Board of Governors of the Federal Reserve System (U.S.).
  7. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," NBER Working Papers 12489, National Bureau of Economic Research, Inc.
  8. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, Bank for International Settlements, March.
  9. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking," BIS Quarterly Review, Bank for International Settlements, Bank for International Settlements, March.
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Cited by:
  1. Ji, Philip Inyeob & In, Francis, 2010. "The impact of the global financial crisis on the cross-currency linkage of LIBOR-OIS spreads," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 20(5), pages 575-589, December.

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