The Dollar, Bank Leverage and the Deviation from Covered Interest Parity

43 Pages Posted: 16 Nov 2016

See all articles by Stefan Avdjiev

Stefan Avdjiev

Bank for International Settlements (BIS)

Wenxin Du

University of Chicago Booth School of Business

Cathérine Koch

Bank for International Settlements (BIS)

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: November 15, 2016

Abstract

We document the triangular relationship formed by the strength of the US dollar, cross-border bank lending in dollars and deviations from covered interest parity (CIP). A stronger dollar goes hand-in-hand with bigger deviations from CIP and contractions of cross-border bank lending in dollars. Differential sensitivity of CIP deviations to the strength of the dollar can explain cross-sectional variations in CIP arbitrage profits. We argue that underpinning the triangle is the role of the dollar as proxy for the shadow price of bank leverage.

Keywords: exchange rates, bank leverage, cross-currency basis

JEL Classification: F3, G1, G2

Suggested Citation

Avdjiev, Stefan and Du, Wenxin and Koch, Catherine and Shin, Hyun Song, The Dollar, Bank Leverage and the Deviation from Covered Interest Parity (November 15, 2016). BIS Working Paper No. 592. Available at SSRN: https://ssrn.com/abstract=2870057

Stefan Avdjiev (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Wenxin Du

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://https://sites.google.com/site/wenxindu/

Catherine Koch

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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