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Demand Effects in the FX Forward Market: Micro Evidence from Banks’ Dollar Hedging

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  • Abbassi Puriya
  • Falk Bräuning

Abstract

Using contract-level supervisory data, we show that dollar forward sales by non-U.S. banks that are initiated at the end of a quarter and mature shortly after it concludes trade at higher prices and higher volumes. These effects are driven by banks with large net on-balance-sheet dollar assets that they can hedge around quarter ends by selling dollars forward (increasing off-balance-sheet short positions), which suggests regulatory arbitrage to reduce capital charges for open foreign exchange (FX) exposure. Our results indicate that demand effects related to banks’ management of FX exposure are an important driver of deviations from covered interest rate parity.

Suggested Citation

  • Abbassi Puriya & Falk Bräuning, 2021. "Demand Effects in the FX Forward Market: Micro Evidence from Banks’ Dollar Hedging," Review of Financial Studies, Society for Financial Studies, vol. 34(9), pages 4177-4215.
    • Handle: RePEc:oup:rfinst:v:34:y:2021:i:9:p:4177-4215.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaa123
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    Citations

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    Cited by:

    1. Abbassi, Puriya & Bräuning, Falk, 2023. "Exchange rate risk, banks' currency mismatches, and credit supply," Journal of International Economics, Elsevier, vol. 141(C).
    2. Robe, Michel A., 2022. "The dollar’s ”Convenience Yield”," Finance Research Letters, Elsevier, vol. 48(C).
    3. Gino Cenedese & Pasquale Della Corte & Tianyu Wang, 2021. "Currency Mispricing and Dealer Balance Sheets," Journal of Finance, American Finance Association, vol. 76(6), pages 2763-2803, December.
    4. Abbassi, Puriya & Iyer, Rajkamal & Peydró, José-Luis & Soto, Paul, 2020. "Stressed Banks? Evidence from the Largest-Ever Supervisory Review," EconStor Preprints 217048, ZBW - Leibniz Information Centre for Economics.
    5. Pēteris Kloks & Patrick McGuire & Angelo Ranaldo & Vladyslav Sushko, 2023. "Bank positions in FX swaps: insights from CLS," BIS Quarterly Review, Bank for International Settlements, September.

    More about this item

    JEL classification:

    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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