The Pricing of FX Forward Contracts: Micro Evidence from Banksâ€™ Dollar Hedging
55 Pages Posted: 11 Oct 2018 Last revised: 21 Feb 2019
Date Written: 2018-03-01
We use transaction-level data on foreign exchange (FX) forward contracts for the period 2014 through 2016 in conjunction with supervisory balance sheet information to study the drivers of banksâ€™ dollar hedging costs. Comparing contracts of the same maturity that are initiated during the same hour of the same day, we find large heterogeneity in banksâ€™ hedging costs. We show that these costs (i) are higher for banks with a larger FX funding gap, (ii) depend on banksâ€™ FX funding composition in terms of the source (interbank versus retail) and rollover structure (long-term versus short-term), (iii) are lower for banks with deeper internal dollar capital markets, and (iv) increase with banksâ€™ shadow cost of capital. Our results are important for understanding how shocks are transmitted internationally through the FX hedging market.
Keywords: FX markets, foreign exchange, dollar hedging, price determination, global banks, international financial shocks
JEL Classification: D40, E43, F30, F31, G15
Suggested Citation: Suggested Citation