Price discovery from cross-currency and FX swaps: a structural analysis

Abstract:

This paper investigates the relative role of price discovery between two long-term swap contracts that exchange U.S. dollars for Japanese yen - the cross-currency basis swap and the foreign exchange (FX) swap - using structural state space models. Our main findings are that: (i) the currency swap market plays a much more dominant role in price discovery than the FX swap market; and (ii) FX swap prices tend to under react to changes in the efficient price, while cross-currency swap prices react almost entirely to them.

JEL Classification Numbers: G12, G14, G15

Keywords: Currency Swap, FX Swap, Price Discovery, State Space Model, Efficient Price