Dollar Shortage, Central Bank Actions, and the Cross Currency Basis
In our model, cross-currency basis, which captures the deviations from covered interest rate parity (CIP), reflects the relative value of the scarcer currency (US dollar) as collateral in funding constraints. Our empirical evidence shows that measures of dollar shortage derived from ECB tenders, and actions to move to fixed-rate tenders with full allotment and to expand the eligible collateral by the ECB have significant power in explaining the cross currency basis. We show that the relaxation of Euro funding constraints through 3-year Long Term Re-financing Operations (LTROs) does not contribute to the narrowing of the cross-currency basis, consistent with the theory developed in the paper.
Jean-Marc Bottazzi, Jaime Luque, Mario Pascoa, and Suresh Sundaresan. 2011. "Dollar Shortage, Central Bank Actions, and the Cross Currency Basis" Available at SSRN. See also previous version: Univ. Carlos III de Madrid Working Paper 11-39 December 2011.
Available at: http://works.bepress.com/luque/9