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  • 2022
  • Working Paper

Markups to Financial Intermediation in Foreign Exchange Markets

By: Jonathan Wallen
  • Format:Print
  • | Language:English
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Abstract

On average from 2013 to 2020, foreign asset managers in net sold forward 1.1 trillion U.S. dollars. This forward sale of dollars hedges the currency mismatch of foreign investment in U.S. dollar assets. By accommodating this demand, U.S. and European banks earn an arbitrage spread, a violation of covered interest rate parity. I document evidence that banks exercise market power in the pricing of the dollar forward rate.
Prices are asymmetrically sensitive to interest rate spreads and arbitrage spreads increase in response to predictable decreases in competition. When competition is low, arbitrage spreads increase five-fold and U.S. banks earn profits of 48-82 million dollars per week.

Keywords

Foreign Exchange; Financial Intermediation; Arbitrage; Market Power; Regulations; Currency; Assets; Interest Rates; Banking Industry

Citation

Wallen, Jonathan. "Markups to Financial Intermediation in Foreign Exchange Markets." Working Paper, March 2022.
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About The Author

Jonathan L. Wallen

Finance
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