Currency Mispricing and Dealer Balance Sheets

We find dealer-level evidence that recent regulation on the leverage ratio requirement causes deviations from covered interest parity. Our analysis uses a unique data set of currency derivatives with disclosed counterparty identities together exogenous variation introduced by U.K. framework. Dealers who are affected regulatory shock charge an additional premium about 20 basis points per annum for synthetic dollar funding relative to unaffected dealers. This finding holds even after controlling changes in clients' demand. Also, some clients increase their trading activity dealers whom they already had preexisting relationship.