Inefficiencies of Basis Swaps to Hedge Foreign Exchange Risk

5 Pages Posted: 9 Jul 2020

See all articles by Camilo Sarmiento

Camilo Sarmiento

Inter-American Development Bank (IDB)

Date Written: June 14, 2020

Abstract

We find that a cross currency basis swap between the U.S. and emerging economies should not be interpreted as a currency hedge, as the exchange rate risk associated with these transactions is quite high. These risks are significantly lower for a basis swap between the U.S. Libor and Euro Libor. Overall, the use of a cross-currency basis swap requires an assessment of the expected trajectories of exchange rates and the associated risks. Offshore funding is thus an imperfect substitute for onshore funding of operations in a local currency.

Keywords: Cross Currency Basis Swap, Hedging, Offshore Funding, Interest Rate Parity

JEL Classification: F21, G2,

Suggested Citation

Sarmiento, Camilo, Inefficiencies of Basis Swaps to Hedge Foreign Exchange Risk (June 14, 2020). Available at SSRN: https://ssrn.com/abstract=3626630 or http://dx.doi.org/10.2139/ssrn.3626630

Camilo Sarmiento (Contact Author)

Inter-American Development Bank (IDB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

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