Xin Long (龙鑫)

Abstract: We explore how covered interest parity deviations—measured by the cross-currency basis (CCB)—affects output growth. Using quarterly data from advanced economies (AE) and emerging markets (EM) in a panel VAR model and local projections, we find that positive shocks to the CCB typically lead to negative responses in output, implying that looser dollar funding conditions induce contractions. This counterintuitive result may be understood by recognizing that the effects of dollar access operates by altering the relative attractiveness of dollar versus non-dollar-denominated assets. During financial crises in AEs, the safe-haven demand for dollar assets is so pronounced that shortfalls in international liquidity become especially debilitating for growth. During normal times, however, easier dollar access in- duces agents in EMs to increase their purchases of local-currency assets, impairing domestic liquidity and hence growth; whereas in AEs, the exchange rate appreciates to compensate holders of local-currency assets, which erodes export competitiveness and growth.

Abstract: The large and persistent deviations in covered interest parity (CIP) observed after the global financial crisis presents a puzzle to international finance, given usual arbitrage opportunities. This paper suggests that a country’s political risk is an underexplored factor in determining the cross-currency basis (CCB), a measure of such deviations. Using data for 33 advanced economy (AE) and emerging market (EM) currencies, we introduce country-specific political risk into the CIP condition, and test if such risk matters for the CCB. To identify the effect of political risk, we employ two strategies: a duration-to-election indicator, which we also pair with democratic accountability as instruments; and, a regression discontinuity around close elections. We find that higher political risks do result in more negative CCBs, consistent with our modified theory. Further explorations reveal that political risks affect CIP deviations differentially in AEs versus EMs, and that international re- serves and dollar swap lines can relieve the effects of political risk. We also show that the results are driven by the effect of unanticipated (rather than systematic) political risk, operating on the synthetic dollar rate.

Abstract: Given the rising use of the U.S. dollar as the invoicing currency in international trade, this paper examines how dollar financing affects firms’ trade behaviors from the perspective of cross-currency basis (CCB), a country-specific indicator of dollar borrowing cost for firms outside the United States. Using a multi-dimensional fixed effect model and two shift share Bartik-like instrument identifications, I take advantage of the disaggregated firm level trade data from Chile between 2009 and 2022, and find that easier access to dollar liquidity increases both firms’ imports and exports, highlighting the important role that dollar liquidity plays in shaping firms' trading behaviors after the global financial crisis. When probing further, I find that CCB works as a better dollar liquidity indicator than the intensively studied broad dollar index. An additional analysis with China echoes the finding from Chile and shows how this effect differentiates in different exchange rate regimes, providing further evidence on the effect of dollar liquidity on trade beyond the scope of a single country. The findings are robust to model specification and variable measurement.