The Dollar, Bank Leverage and Deviations from Covered Interest Rate Parity

Transcription

1 The Dollar, Bank Leverage and Deviations from Covered Interest Rate Parity Stefan Avdjiev*, Wenxin Du**, Catherine Koch* and Hyun Song Shin* *Bank for International Settlements, ** Federal Reserve Board Princeton JRCPPF, February 22, 2018 The views expressed in this presentation are those of the authors and not necessarily those of the Bank for International Settlements, the Federal Reserve Board of Governors, or the Federal Reserve System Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

2 Overview intermediation by the global banking system mirrors the underlying currency hedging demands. 11 The Role of the U.S. Dollar Cross-border US dollar-denominated credit, all sectors In trillions of US dollars Graph 6 Cross-border U.S. dollar-denomianted bank claims and liabilities ($trillions) By residence By nationality Claims (+) and liabilities (-) of: Euro area Switzerland United Kingdom Japan United States Other Source: BIS Locational Banking Statistics 1 The break in series between Q and Q is due to the Q introduction of a more comprehensive reporting of cross-border positions. For more details, see Source: BIS locational banking statistics, Tables A5 (by residence) and A7 (by nationality). Size of FX forward and swap markets: Graph 6 provides a window on the total dollar-denominated cross-border bank intermediation arranged Notional by jurisdiction. outstanding: In both panels, $61 trillion; upward-pointing daily trading bars indicate volume: cross-border $3 trillion assets and downward-pointing bars indicate cross-border liabilities. The left-hand panel breaks out the total by residence, while the right-hand panel breaks out the total by nationality, meaning the location of the Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

3 Overview Covered Interest Rate Parity (CIP) No-Arbitrage Argument for CIP: Borrow $1 at the U.S. dollar risk-free rate y $ Exchange $1 into St units of foreign currency; Invest at foreign risk-free rate yt; Convert the proceeds back at the pre-determined forward rate Ft; No risk, no profits: S t(1 + y t)/f t = 1 + y $ t or in logs: t ; ρ t f t s t = y t y $ t. In other words, y t $ }{{} = y t ρ }{{} t cash market swap market In every international finance textbook, but no longer true. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

4 Overview Failure of CIP Cross-currency basis = cash market $ rate - swap market $ rate: x t,t+n = y t,t+n $ }{{} [y t,t+n ρ t,t+n ]. }{{} cash market swap market Figure 1: 3M (left) and 5Y (right) cross-currency basis Basis Points Basis Points AUD CAD CHF DKK EUR AUD CAD CHF DKK EUR GBP JPY NOK NZD SEK GBP JPY NOK NZD SEK Source: Du, Tepper, Verdelhan (Forthcoming) Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

5 Overview Level of CIP Deviations at Quarter Ends Why is not the basis arbitraged away? Constraints on banks balance sheet. Figure 1. Quarter-End Anomaly for the CIP Deviations (Yen basis) Basis Point /31/14 3/31/15 6/30/15 9/30/15 12/30/15 3/31/16 6/30/16 9/30/16 12/31/16 3/31/17 6/30/17 9/30/17 12/29/17 1w deviation 1m deviation 3m deviation Source: Du, Tepper, Verdelhan (Forthcoming) Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

6 Overview This Paper: Spot-Basis-XB Flows Triangle Broad Dollar Cross-Currency Basis XB flows Stronger dollar, wider CIP deviations, lower cross-border lending in dollars The dollar is a risk barometer in global capital markets: stronger dollar, higher shadow cost of banks balance sheet capacity and lower bank leverage. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

7 Overview Broad Dollar and the Basis Post-GFC FRB broad dollar index (lhs) Mean cross-currency basis swap spread (rhs) Cross-currency basis = cash market $ rate - swap market $ rate. The cross-currency basis is the mirror image of dollar strength. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

8 Overview Broad Dollar and the Basis Post-GFC FRB broad dollar index (lhs) Mean cross-currency basis swap spread (rhs) Cross-currency basis = cash market $ rate - swap market $ rate. The cross-currency basis is the mirror image of dollar strength. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

9 Overview Broad Dollar and the Basis Post-GFC FRB broad dollar index (lhs) Mean cross-currency basis swap spread (rhs) Cross-currency basis = cash market $ rate - swap market $ rate. The cross-currency basis is the mirror image of dollar strength. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

10 Overview Broad Dollar and the Basis ( ) Jan 1997= FRB broad dollar index (lhs) Mean cross currency basis spread (rhs) Basis Points Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

11 Overview Related Literature Failure of CIP: CIP deviations during the crisis : Baba and Packer (2009), Baba, Packer and Nagano (2008), Baba, McCauley and Ramaswamy (2009), Bottazzi et al. (2012), Coffey, Hrung and Sarkar (2009), McGuire and von Peter (2009), Goldberg, Kennedy and Miu (2011), Griffoli and Ranaldo (2011), Ivashina, Scharfstein and Stein (2015) Recent work: Du, Tepper and Verdlehan (Forthcoming), Borio et al. (2016) and Sushko et al. (2016), Liao (2016), Iida et al. (2016), Rime et al. (2016) Intermediary and margin-based asset pricing: Bernanke and Gertler (1989), Holmstrom and Tirole (1997), Brunnermeier and Pedersen (2009), Garleanu and Pedersen (2011), He and Krishnamurthy (2012,2013), Brunnermeier and Sannikov (2014), Adrian and Shin (2014), Adrian et. al. (2014). Risk-taking channel of exchange rates: Bruno and Shin (2015ab) FX spot determination in the presence of financial market frictions: Gabaix and Maggiori (2016) Dollar factor in exchange rates and equity markets: Verdelhan (Forthcoming), Brusa, Ramadorai and Verdelhan (2017). Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

12 Spot and Basis Spot and Basis Broad Dollar Cross-Currency Basis XB flows Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

13 Spot and Basis Broad Dollar and the Basis FRB broad dollar index (lhs) Mean cross-currency basis swap spread (rhs) Cross-currency basis = cash market $ rate - swap market $ rate. The cross-currency basis is the mirror image of dollar strength. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

14 Spot and Basis Daily Regression of 3M Basis on the Dollar Table 2: Regression results of the 3-month cross-currency basis (daily frequency) (1) (2) (3) (4) (5) (6) ΔDollar t *** *** *** *** *** (0.539) (0.775) (0.767) (0.658) (0.684) ΔBER it ** (0.263) (0.324) (0.316) (0.266) (0.269) ln VIX t (0.411) (0.399) (0.409) ΔlnVIX t (0.0188) (0.0197) (0.0189) ΔCurrV ol it *** *** (0.0576) (0.0571) ΔRR it (0.806) (0.827) Δ(y it yit US ) ** Δ(ts it ts US it ) (0.0370) * (0.0501) Observations 25,166 26,513 25,166 24,604 24,530 23,426 R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

15 Spot and Basis Daily Regression of 3M Basis on the Dollar Table 2: Regression results of the 3-month cross-currency basis (daily frequency) (1) (2) (3) (4) (5) (6) ΔDollar t *** *** *** *** *** (0.539) (0.775) (0.767) (0.658) (0.684) ΔBER it ** (0.263) (0.324) (0.316) (0.266) (0.269) ln VIX t (0.411) (0.399) (0.409) ΔlnVIX t (0.0188) (0.0197) (0.0189) ΔCurrV ol it *** *** (0.0576) (0.0571) ΔRR it (0.806) (0.827) Δ(y it yit US ) ** Δ(ts it ts US it ) (0.0370) * (0.0501) Observations 25,166 26,513 25,166 24,604 24,530 23,426 R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

16 Spot and Basis Daily Regression of 3M Basis on the Dollar Table 2: Regression results of the 3-month cross-currency basis (daily frequency) (1) (2) (3) (4) (5) (6) ΔDollar t *** *** *** *** *** (0.539) (0.775) (0.767) (0.658) (0.684) ΔBER it ** (0.263) (0.324) (0.316) (0.266) (0.269) ln VIX t (0.411) (0.399) (0.409) ΔlnVIX t (0.0188) (0.0197) (0.0189) ΔCurrV ol it *** *** (0.0576) (0.0571) ΔRR it (0.806) (0.827) Δ(y it yit US ) ** Δ(ts it ts US it ) (0.0370) * (0.0501) Observations 25,166 26,513 25,166 24,604 24,530 23,426 R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

17 Spot and Basis Quarterly Regression of 5Y Basis on the Dollar Table 3: Regression results of the 5-year cross-currency basis (quarterly frequency) (1) (2) (3) (4) (5) (6) ΔDollar t *** ** ** ** ** (0.276) (0.408) (0.334) (0.366) (0.325) ΔBER it *** * (0.102) (0.123) (0.112) (0.145) (0.145) ln VIX t (2.172) (2.123) (2.041) ΔlnVIX t (0.0237) (0.0274) (0.0304) ΔCurrV ol it (0.0440) (0.0388) ΔRR it (1.008) (0.932) Δ(y it yit US ) *** (0.0227) Δ(ts it ts US it ) (0.0148) Observations R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

18 Spot and Basis Quarterly Regression of 5Y Basis on the Dollar Table 3: Regression results of the 5-year cross-currency basis (quarterly frequency) (1) (2) (3) (4) (5) (6) ΔDollar t *** ** ** ** ** (0.276) (0.408) (0.334) (0.366) (0.325) ΔBER it *** * (0.102) (0.123) (0.112) (0.145) (0.145) ln VIX t (2.172) (2.123) (2.041) ΔlnVIX t (0.0237) (0.0274) (0.0304) ΔCurrV ol it (0.0440) (0.0388) ΔRR it (1.008) (0.932) Δ(y it yit US ) *** (0.0227) Δ(ts it ts US it ) (0.0148) Observations R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

19 Spot and Basis Quarterly Regression of 5Y Basis on the Dollar Table 3: Regression results of the 5-year cross-currency basis (quarterly frequency) (1) (2) (3) (4) (5) (6) ΔDollar t *** ** ** ** ** (0.276) (0.408) (0.334) (0.366) (0.325) ΔBER it *** * (0.102) (0.123) (0.112) (0.145) (0.145) ln VIX t (2.172) (2.123) (2.041) ΔlnVIX t (0.0237) (0.0274) (0.0304) ΔCurrV ol it (0.0440) (0.0388) ΔRR it (1.008) (0.932) Δ(y it yit US ) *** (0.0227) Δ(ts it ts US it ) (0.0148) Observations R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

20 Spot and Basis Dollar Beta by Currency Dollar beta by currency: x it = α i + β i Dollar t + ɛ it Table 4: Dollar beta by country (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) AUD CAD CHF DKK EUR GBP JPY NOK NZD SEK Panel (A): 3-month basis, daily frequency Broad t *** *** *** *** *** *** *** *** *** (0.344) (0.301) (0.354) (0.386) (0.312) (0.311) (0.297) (0.358) (0.340) (0.329) Panel (B): 5-year basis, quarterly frequency Broad t *** *** *** *** *** *** *** (0.379) (0.546) (0.374) (0.608) (0.479) (0.292) (0.520) (0.278) (0.408) (0.235) Notes: This table reports regression coefficients of changes in the cross-currency basis of currency i on the changes in the broad dollar. Panel A shows regressions based on daily changes using the three-month cross-currency basis and Panel B shows results based on quarterly changes using the five-year cross-currency basis. We winsorize the daily changes in the cross-currency basis at 1 percent on both tails. The sample period is January 1, 2007 to December 8, Robust standard errors are shown in the parentheses. ***p<0.01, **p<0.05, *p<0.1. Table 5: Dollar beta and the cross-currency basis (1) (2) Mean 3M Basis Mean 5Y Basis Avdjiev, Du, Koch and Shin (BIS and FRB) β i Dollar, Bank Leverage, 16.89*** CIP Deviations 32.06*** JRCPPF, February 22, / 25

21 Spot and Basis Cross-Currency Basis vs. Dollar Beta The dollar beta is strongly correlated with the level of the basis. The dollar is a risk factor pricing the cross-section of CIP arbitrage returns. Reversal roles of safe-haven and risky currencies. 3M basis (bps) EUR 3M basis vs. dollar beta (corr=75%) JPY SEK DKK AUD CAD GBP CHF NOK NZD Dollar beta 5Y basis (bps) JPY 5Y basis vs. dollar beta (corr=97%) DKK EUR CHF SEK GBP NOK CAD Dollar beta NZD AUD Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

22 Spot and Basis The Dollar and Basis after the U.S. Election The relationship between the dollar beta and the basis is strongly confirmed in the event study after the U.S. election. Changes in the broad dollar index and three-month cross-currency basis since the US election 8/11/ 29/11/ dollar Currency change beta 1 Broad dollar (3.9%) AUD bps 0.64 CAD bps 2.56 CHF bps 3.97 DKK bps 4.14 EUR bps 3.75 GBP bps 1.79 JPY bps 5.18 NZD bps 0.70 NOK bps 2.10 SEK bps 2.98 Cross-currency basis vs dollar beta 2 1 The dollar beta is calculated as the ratio of changes in the three-month cross-currency basis over changes in the broad US dollar index between 8 November and 29 November The vertical axis shows the three-month cross-currency basis expressed in basis points on 8 November 2016, while the horizontal axis indicates the dollar beta. Sources: Board of Governors of the Federal Reserve System; Bloomberg; BIS calculations. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

23 Spot and Flows Spot and XB Flows Broad Dollar Cross-Currency Basis XB flows Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

24 Spot and Flows XB Dollar Flows and the Board Dollar Index Growth rates in USD lending (%) Q Change in broad dollar index (%) Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

25 Spot and Flows Panel Regression of Bilateral $XB Flows on the Dollar xbl it = α i + β Dollar t + γ BER it + δcontrl t + ɛ it Table 8: Panel Regressions of dollar cross-border lending on the broad dollar (1) (2) (3) (4) (5) (6) benchmark equal-weight since GFC DM EM OFC ΔDollar t *** *** *** ** *** *** (0.117) (0.100) (0.134) (0.115) (0.155) (0.143) ΔBER it *** ** * *** *** ** (0.0524) (0.0308) (0.0936) (0.0808) (0.0348) (0.115) ln VIX t ** *** * ** *** ** (0.869) (0.637) (0.917) (0.944) (1.094) (0.377) ΔlnVIX t ** (0.0131) ( ) (0.0113) (0.0146) ( ) (0.0320) ΔIR US,t ** (0.650) (0.439) (0.811) (0.681) (0.692) (1.262) Observations 6,759 6,759 4,133 1,943 4, R-Squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

26 Spot and Flows Evidence from the Structural Panel VAR Structural panel VAR based on the Cholesky decomposition, where y it = [ ir US,t, ir i,t, ln VIX t, xbl it, Dollar t ]. We rank xbl it before Dollar t to tilt the odds against finding effects of the exchange raters on xb-flows. Results are robust to alternative ordering. All countries Developed markets Emerging markets Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

27 Model Triangle Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

28 Model Extended Triangle Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

29 Bank Equities Negative Impact of A Stronger Dollar on Bank Equities Regressions of bank equity returns on the broad dollar movements (1) (2) (3) Bank Equity Return Bank Equity Return Bank Equity Return Broad t *** ** (0.127) (0.103) (0.0838) Broad t bs t 2.875*** (0.808) Market t 1.246*** 1.236*** (0.0527) (0.0524) Constant *** *** *** (3.25e-05) ( ) ( ) Observations 3,755 3,755 3,755 R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

30 such as the Australia, bank equities Bankactually Equities respond positively to a dollar appreciation after controlling for benchmark equity index returns. Dollar, Bank Equity and the Basis Bank Figure equity s 8: Sensitivity dollar beta of bank (normalized equity returns bytomarket s the dollar dollar vs. cross-currency beta) vs. the basis basis Bank dollar beta / Market dollar beta JPY DKK CHF EUR NOK GBP Mean 5Y Basis (bps) SEK USD CAD AUD Notes: On the x-axis, we plot the mean 5-year cross-currency basis by currency. On the y-axis, A stronger we plot the dollar average hasratio a negative of the regression effect on betabank of changes equities. in the bank equities on changes The effect in the is broad stronger dollar index for banks over the in regression countriesbeta with of achanges moreinegative the benchmark equity cross-currency index on changes basis, in the or abroad moredollar severe indexdollar by currency. shortage. The sample period is Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

31 Conclusion Conclusion Triangular relationship among The value of the dollar CIP deviations XB lending denominated in the dollar The U.S. dollar is a barometer of risk-bearing capacity in global capital markets. A dollar appreciation corresponds to higher shadow cost of bank balance sheet capacity and lower bank leverage. Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25

32 Conclusion Appendix Regression results of the cross-currency basis on dollar exchange rates (1) (2) (3) (4) Daily Δx t,t+3m Daily Δx t,t+3m Quarterly Δx t,t+5y Quarterly Δx t,t+5y ΔDollart EM *** ** ** ** (0.988) (1.014) (0.415) (0.394) ΔDollart DM (0.434) (0.440) (0.302) (0.257) ΔBER it ** (0.279) (0.237) (0.123) (0.143) ln VIX t (0.409) (0.409) (2.152) (2.045) ΔlnVIX t (0.0192) (0.0199) (0.0295) (0.0340) ΔCurrV ol it *** (0.0567) (0.0376) ΔRR it (0.817) (0.913) Δ(y it yit US ) ** *** (0.0371) (0.0226) Δ(ts it ts US it ) * (0.0500) (0.0148) Observations 24,604 23, R-squared Avdjiev, Du, Koch and Shin (BIS and FRB) Dollar, Bank Leverage, CIP Deviations JRCPPF, February 22, / 25