Offshore Dollar Funding Shocks and the Dollar Exchange Rate

Philippe Bacchetta, Jonathan Davis and Eric Van Wincoop

No 425, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: Deviations from covered interest rate parity (CIP) have persisted since the global financial crisis, reflecting a segmentation between onshore (U.S.) and offshore dollar markets. This segmentation can give rise to dollar shortages in offshore markets during periods of financial stress. We propose a model with limited CIP and UIP arbitrage where the CIP deviation and exchange rate are jointly determined by equilibrium in the swap and spot FX markets. We consider offshore dollar funding shocks, where either the supply of dollar funding by the U.S. to offshore markets declines or the demand for dollar funding in offshore markets rises. We show that this gives rise to dollar shortages, with a rise in the CIP deviation and appreciation of the dollar. In contrast to other models of exchange rate determination, the dollar appreciation is entirely due to imperfect CIP arbitrage.

Keywords: U.S. Dollar; exchange rate; CIP deviations (search for similar items in EconPapers)
JEL-codes: F31 G15 (search for similar items in EconPapers)
Pages: 35
Date: 2023-12-15, Revised 2026-05-05
New Economics Papers: this item is included in nep-ban, nep-ifn, nep-mon and nep-opm
Note: Previous versions circulated under the titles “Dollar Shortages, CIP Deviations, and the Safe Haven Role of the Dollar” and “Exchange Rate Determination under Limits to CIP Arbitrage.”
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.dallasfed.org/~/media/documents/resear ... pers/2023/0425r2.pdf Full text (application/pdf)
https://www.dallasfed.org/~/media/documents/resear ... ers/2023/0425ar2.pdf Appendix (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:97492

DOI: 10.24149/gwp425r2

Access Statistics for this paper

More papers in Globalization Institute Working Papers from Federal Reserve Bank of Dallas Contact information at EDIRC.
Bibliographic data for series maintained by Amy Chapman ().