The dollar squeeze of the financial crisis
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.
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- Bottazzi, Jean-Marc & Luque, Jaime & Páscoa, Mário R., 2012.
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