Currency Mispricing and Dealer Balance Sheets
88 Pages Posted: 12 Feb 2019 Last revised: 14 Apr 2020
Date Written: April 13, 2020
We find dealer-level evidence that recent regulation on the leverage ratio requirement causes deviations from covered interest parity. Our analysis uses a unique dataset of contract-level currency derivatives with disclosed counterparty identities and a plausibly exogenous variation arising with the introduction of the UK leverage ratio framework. We find that affected dealers, after the regulatory change, charge a premium to clients that synthetically borrow dollars through the foreign exchange market relative to unaffected dealers, even after controlling for changes in clients' demand. Also, some clients increase their trading activity with unaffected dealers with whom they already had a pre-existing relationship.
Keywords: Exchange rates, dollar basis covered interest parity condition, arbitrage opportunities
JEL Classification: F31, G12, G15
Suggested Citation: Suggested Citation