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The dollar squeeze of the financial crisis

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  • Bottazzi, Jean-Marc
  • Luque, Jaime
  • Pascoa, Mario R.
  • Sundaresan, Suresh

Abstract

By Covered Interest rate Parity (CIP), the FX swap implied currrency interest rates should coincide with actual interest rates. When a difference occurs, the residual is referred to as the cross currency basis. We link the Euro- Dollar currency basis (e.g. in 2008) to shadow prices of dollar funding constraints and interpret the basis as the relative physical possession value of the scarcer currency, or the “convenience yield” associated with that currency. This is similar to specialness in repo markets, expressing the physical possession value of a security. We examine how the coordinated central banks intervention can reduce the currency basis.

Suggested Citation

  • Bottazzi, Jean-Marc & Luque, Jaime & Pascoa, Mario R. & Sundaresan, Suresh, 2011. "The dollar squeeze of the financial crisis," UC3M Working papers. Economics we1139, Universidad Carlos III de Madrid. Departamento de Economía.
  • Handle: RePEc:cte:werepe:we1139
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    References listed on IDEAS

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    1. Dimitri Vayanos & Pierre-Olivier Weill, 2008. "A Search-Based Theory of the On-the-Run Phenomenon," Journal of Finance, American Finance Association, vol. 63(3), pages 1361-1398, June.
    2. Niall Coffey & Warren B. Hrung & Asani Sarkar, 2009. "Capital constraints, counterparty risk, and deviations from covered interest rate parity," Staff Reports 393, Federal Reserve Bank of New York.
    3. Bottazzi, Jean-Marc & Luque, Jaime & Páscoa, Mário R., 2012. "Securities market theory: Possession, repo and rehypothecation," Journal of Economic Theory, Elsevier, vol. 147(2), pages 477-500.
    4. Baba, Naohiko & Packer, Frank, 2009. "From turmoil to crisis: Dislocations in the FX swap market before and after the failure of Lehman Brothers," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1350-1374, December.
    5. Duffie, Darrell & Garleanu, Nicolae & Pedersen, Lasse Heje, 2002. "Securities lending, shorting, and pricing," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 307-339.
    6. Jordan, Bradford D & Jordan, Susan D, 1997. " Special Repo Rates: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 52(5), pages 2051-2072, December.
    7. Leonardo Bartolini & Spence Hilton & Suresh Sundaresan & Christopher Tonetti, 2011. "Collateral Values by Asset Class: Evidence from Primary Securities Dealers," Review of Financial Studies, Society for Financial Studies, vol. 24(1), pages 248-278.
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    Cited by:

    1. Luna Azahara Romo González, 2016. "The drivers of European banks’ US dollar debt issuance: opportunistic funding in times of crisis?," Working Papers 1611, Banco de España;Working Papers Homepage.

    More about this item

    Keywords

    FX swaps;

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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