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

  • 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)

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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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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  1. James McAndrews & Asani Sarkar & Zhenyu Wang, 2008. "The effect of the Term Auction Facility on the London Inter-Bank Offered Rate," Staff Reports 335, Federal Reserve Bank of New York.
  2. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
  3. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347 National Bureau of Economic Research, Inc.
  4. Joseph E. Gagnon & Alain P. Chaboud, 2007. "What can the data tell us about carry trades in Japanese yen?," International Finance Discussion Papers 899, Board of Governors of the Federal Reserve System (U.S.).
  5. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking," BIS Quarterly Review, Bank for International Settlements, March.
  6. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  7. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," 2006 Meeting Papers 864, Society for Economic Dynamics.
  8. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers 311, Society for Economic Dynamics.
  9. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
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