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The pricing of FX forward contracts: Micro evidence from banks' dollar hedging

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  • Abbassi, Puriya
  • Bräuning, Falk

Abstract

Using transaction-level data on foreign exchange (FX) forward contracts, we document large demand-driven heterogeneity in banks' dollar hedging costs. For identification, we exploit regulatory end-of-quarter reporting that penalizes banks' currency exposure with capital surcharges. Contracts that reduce quarter-end currency exposure trade at higher prices, specifically for banks with high dollar funding gaps and high leverage, while access to internal dollar capital markets and bargaining power reduces prices. Spreads between similar contracts with and without initial margin widen with leverage. Our results suggest that banks' shadow costs of capital are important for the international propagation of shocks through FX derivatives markets.

Suggested Citation

  • Abbassi, Puriya & Bräuning, Falk, 2018. "The pricing of FX forward contracts: Micro evidence from banks' dollar hedging," Discussion Papers 42/2018, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdps:422018
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    Cited by:

    1. Ingomar Krohn & Vladyslav Sushko, 2020. "FX spot and swap market liquidity spillovers," BIS Working Papers 836, Bank for International Settlements.
    2. Rosati, Simonetta & Vacirca, Francesco, 2019. "Interdependencies in the euro area derivatives clearing network: a multi-layer network approach," Working Paper Series 2342, European Central Bank.
    3. Dalla Fontana, Silvia & Holz auf der Heide, Marco & Pelizzon, Loriana & Scheicher, Martin, 2019. "The anatomy of the euro area interest rate swap market," Working Paper Series 2242, European Central Bank.
    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.

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    More about this item

    Keywords

    FX markets; hedging; price determination; global banks; international finance;
    All these keywords.

    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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