The Korean Journal of Economic Studies
Effects of the Central Bank Liquidity Swap on Korean FX Markets - The Case during the COVID-19 Crisis
Youngjin Yun (Bank of Korea)Year 2021Vol. 69No. 3
This paper estimates the effects of the central bank liquidity swap, arranged during the COVID-19 crisis, on the Korean FX market. I analyze the daily fluctuation of the exchange rate and the covered interest rate parity deviation between February and May 2020. I estimate the liquidity swap effect 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 duringthe COVID-19 crisis. The Korean won gained as much as 3.3% on the day of the currency swap announcement, and remained elevated throughout the subsequent two weeks period, rising at an average rate of 2.1%. The won 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 find that the deviation was kept below the theoretical ceiling after the swap arrangement.