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Dollar Shortages, CIP Deviations and the Safe Haven Role of the Dollar

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  • Philippe Bacchetta
  • J. Scott Davis
  • Eric Van Wincoop

Abstract

Since 2007, an increase in risk or risk aversion has resulted in a U.S. dollar appreciation and greater deviations from covered interest parity (CIP). In contrast, prior to 2007, risk had no impact on the dollar, and CIP held. To explain these phenomena, we develop a two-country model featuring (i) market segmentation, (ii) limited CIP arbitrage (since 2007) and (iii) global dollar dominance. During periods of heightened global financial stress, dollar shortages in the offshore market emerge, leading to increased CIP deviations and a dollar appreciation. The appreciation occurs even in the absence of global dollar demand shocks. Central bank swap lines mitigate these effects.

Suggested Citation

  • Philippe Bacchetta & J. Scott Davis & Eric Van Wincoop, 2023. "Dollar Shortages, CIP Deviations and the Safe Haven Role of the Dollar," Globalization Institute Working Papers 425, Federal Reserve Bank of Dallas.
    • Handle: RePEc:fip:feddgw:97492
    DOI: 10.24149/gwp425
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    References listed on IDEAS

    as
    1. He, Zhiguo & Kelly, Bryan & Manela, Asaf, 2017. "Intermediary asset pricing: New evidence from many asset classes," Journal of Financial Economics, Elsevier, vol. 126(1), pages 1-35.
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    More about this item

    Keywords

    dollar; CIP deviations; Central Bank Swap Lines;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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