Price Discovery from Cross-Currency and FX Swaps: A Structural Analysis

Yasuaki Amatatsu and Naohiko Baba
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Yasuaki Amatatsu: Bank of Japan
Naohiko Baba: Bank of Japan

No 07-E-12, Bank of Japan Working Paper Series from Bank of Japan

Abstract: This paper investigates the relative role of price discovery between two long-term swap contracts that exchange between the U.S. dollar and the Japanese yen: cross-currency basis swap and FX (foreign exchange) swap. First, we show that these two swaps should be in a no-arbitrage relationship by allowing for differential risk premiums. Second, we empirically investigate the relative role of price discovery using the structural-form approach based on the state space models. Main finding are as follows. (i) The efficient prices extracted as a common factor of the two swaps show a very similar movement, regardless of model specifications. (ii) The currency swap market plays a much more dominant role in price discovery than the FX swap market. (iii) The FX swap prices tend to under-react to the efficient price changes, while the cross-currency swap prices almost exactly react to them.

Keywords: Currency Swap; FX Swap; Price Discovery; State Space Model; Efficient Price (search for similar items in EconPapers)
JEL-codes: G12 G14 G15 (search for similar items in EconPapers)
Date: 2007-07
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Citations: View citations in EconPapers (1)

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