Risk, Specialization, and Covered-Interest Parity
Prevailing theories of financial intermediation assume an integrated financial sector with frictionless risk sharing. However, we identify substantial risk-sharing frictions linked to intermediary specialization using currency derivatives markets as a laboratory. Using confidential supervisory data covering $25 trillion in daily bank exposures, we document imperfect hedging in banks’ FX-swap intermediation: banks rarely hedge their synthetic dollar lending with maturity-matched foreign safe assets. Intermediaries specialize in markets where they have expertise in managing the associated exposures, giving rise to cross-market variation in deviations from covered-interest parity. Our results highlight the importance of intermediary specialization and its impact on risk premia.
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Copy CitationTobias J. Moskowitz, Chase P. Ross, Sharon Y. Ross, and Kaushik Vasudevan, "Risk, Specialization, and Covered-Interest Parity," NBER Working Paper 32707 (2024), https://doi.org/10.3386/w32707.Download Citation
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