Currency mispricing and dealer balance sheets

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 15 February 2019

Staff Working Paper No. 779

By Gino Cenedese, Pasquale Della Corte and Tianyu Wang

We relate currency mispricing originating from the breakdown of covered interest rate parity to the dealer balance-sheet constraints resulting from the post-crisis financial regulation. Using a unique data set on contract-level foreign exchange derivatives with disclosed counterparty identities, we find that dealers with a higher leverage ratio demand an additional premium from their clients for synthetic dollar funding. We handle endogeneity using two exogenous variations associated with the public disclosure of the leverage ratio, and the introduction of the UK leverage ratio framework while controlling for changes in demand conditions at the client level.

PDFCurrency mispricing and dealer balance sheets