Suppose a rational agent can invest in domestic bonds (Euro (EUR) corporates) and foreign bonds (Dollar (USD) corporates) hedged into EUR using cross-currency swaps. Let xccy represent the cross-currency basis spread of the FX hedging, where xccy measures deviations from covered interest parity...

This working paper was written by Patrick Augustin (McGill University and Canadian Derivatives Institute), Mikhail Chernov (University of California Los Angeles, NBER and CEPR), Lukas Schmid (University of Southern California and CEPR) and Dongho Song (Johns Hopkins University).We show...