Dynamic Spillover of Money Market Turmoil from FX Swap to Cross-Currency Swap Markets: Evidence from the 2007–2008 Turmoil

Abstract

This paper investigates the dynamic spillover of 2007–08 money market turmoil from short-term FX swap to the longer-term cross-currency swap markets. Under the turmoil, the short-term covered parity (CIP) deviation (FX swap deviation) and long-term CIP deviation (cross-currency swap price) are significantly in a one-on-one cointegrating relationship. The Granger test shows a significant causality from the short-term to long-term deviation. The bivariate GARCH model reveals a significant volatility spillover in the same direction and a substantial shift-up in conditional correlation. The principal component analysis shows that these deviations are driven largely by the factors that characterize the money market turmoil.