Currency Mispricing and Dealer Balance Sheets

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 currency derivatives with disclosed counterparty identities together with exogenous variation introduced by the UK leverage ratio framework. Dealers that are affected by the regulatory shock charge an additional premium of about 20 basis points per annum for synthetic dollar funding relative to unaffected dealers. This finding holds 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

Cenedese, Gino and Della Corte, Pasquale and Wang, Tianyu, Currency Mispricing and Dealer Balance Sheets (December 11, 2020). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3327088 or http://dx.doi.org/10.2139/ssrn.3327088