 The widening of cross-currency basis: When increased FX swap demand meets limits of arbitrageNadav Ben Zeev and Daniel Nathan Journal of International Economics, 2024, vol. 152, issue C Abstract: This paper examines customer demand-side factors that affect deviation from covered interest rate parity (CIP) with respect to the dollar (i.e., cross-currency basis), particularly when arbitrageurs are constrained. Using novel detailed daily transaction-level data on the universe of Israeli institutional investors (IIs), we employ a granular instrumental variable (GIV) estimation to investigate how IIs’ FX swap demand affects CIP deviation. Our findings demonstrate that a one standard deviation shock to IIs’ FX swap demand when capital is abundant has no effect on IIs’ basis. However, when capital is scarce, the demand shock produces a significant reduction of 12 basis points in IIs’ basis. Our results showcase how limits of arbitrage, together with demand shocks from a large customer base, can drive CIP deviations. Keywords: LOA-dependent FX swap demand channel; Cross-currency basis; Limits of arbitrage; Granular instrumental variable; Bartik instrument; Open FX swap position; Institutional investors (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:152:y:2024:i:c:s0022199624001119 DOI: 10.1016/j.jinteco.2024.103984 Access Statistics for this article Journal of International Economics is currently edited by Gourinchas, Pierre-Olivier and RodrÃguez-Clare, Andrés More articles in Journal of International Economics from Elsevier |
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