[2021-6] Effects of the Central Bank Liquidity Swap on Korean FX Markets - The Case during the COVID-19 Crisis

Macro Economy
Central Bank Liquidity Swap Korean FX Markets COVID-19 Crisis Exchange Rate Interest Rate Parity Deviation
Research Department(02-759-4150)

This paper estimates the effects of the central bank liquidity swap, arranged during the COVID-19 crisis, on Korean FX markets. I analyze the daily fluctuation of the exchange rate and the covered interest rate parity deviation between February and May 2020. The liquidity swap effect is estimated using the local projection method deployed in a differences-in-differences setup. I compare the differences in FX market conditions in Korea and in 17 other countries after the liquidity swap events. Both the announcement effects and the liquidity auction effects are estimated. The results indicate that the central bank liquidity swap played a crucial role in stabilizing the Korean FX market during the COVID-19 crisis. The Korean won appreciated by 3.3% due to the announcement of the swap arrangement, and it also appreciated by 0.5% for each of the six liquidity auctions. The swap line effect on the covered interest rate parity deviation was not clear. However, I did find that the deviation was kept below the theoretical ceiling after the swap arrangement.

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