The Pricing of FX Forward Contracts: Micro Evidence from Banks' Dollar Hedging

56 Pages Posted: 29 Oct 2018 Last revised: 21 Feb 2019

See all articles by Puriya Abbassi

Puriya Abbassi

Deutsche Bundesbank

Falk Bräuning

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: 2018

Abstract

Using transaction-level data on foreign exchange (FX) forward contracts, we document large demand-driven heterogeneity in banks' dollar hedging costs. For identification, we exploit regulatory end-of-quarter reporting that penalizes banks' currency exposure with capital surcharges. Contracts that reduce quarter-end currency exposure trade at higher prices, specifically for banks with high dollar funding gaps and high leverage, while access to internal dollar capital markets and bargaining power reduces prices. Spreads between similar contracts with and without initial margin widen with leverage. Our results suggest that banks' shadow costs of capital are important for the international propagation of shocks through FX derivatives markets.

Keywords: FX markets, hedging, price determination, global banks, international finance

JEL Classification: D40, E43, F30, F31, G15

Suggested Citation

Abbassi, Puriya and Bräuning, Falk, The Pricing of FX Forward Contracts: Micro Evidence from Banks' Dollar Hedging (2018). Deutsche Bundesbank Discussion Paper No. 42/2018. Available at SSRN: https://ssrn.com/abstract=3273756

Puriya Abbassi (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany
00496965993708 (Phone)

Falk Bräuning

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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