Liquidity, Risk Appetite and Exchange Rate Movements during the Financial Crisis of 2007-2009
Hong Kong Monetary Authority Working Paper No. 11/2009
23 Pages Posted: 30 Jun 2009 Last revised: 5 Jun 2018
Date Written: June 29, 2009
Abstract
Given the deleveraging process in the banking sector, banks were reluctant to lend funds in the inter-bank market because of uncertainty about their own future need for funds during the financial crisis of 2007-2009. Aggregate liquidity then declined. This paper investigates the impact of the market-wide liquidity risk and carry-trade incentives on exchange rate movements. The results suggest that liquidity risk measured by the spread between Libor and the overnight index swap rate was a significant factor affecting the exchange rate movements of the euro, the British pound and the Swiss franc, while carry trades were important for the yen, the Australia dollar and the New Zealand dollar.
Keywords: Sub-prime crisis, carry trades, liquidity, leverage
JEL Classification: F31, F32, F33
Suggested Citation: Suggested Citation