Explanation:
Deviations from Covered Interest Parity (CIP) create a cross-currency basis. A positive or non-zero FX swap basis can persist because of limits to arbitrage. Post-2008 regulatory changes have imposed higher capital and balance sheet costs on banks (arbitrageurs). As a result, they demand a premium to provide arbitrage capital and pass these balance sheet costs on via the forward FX swap price. Options B, C, and D typically decrease the swap basis or alter demand in ways that don't correctly explain persistent positive basis from structural arbitrageur constraints.
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A
A positive FX swap basis may exist because arbitrageurs pass on their balance sheet borrowing costs through the forward FX swap price.
B
A persistent and positive FX swap basis is likely to result from non-financial firms issuing debt denominated in their home currency in offshore capital markets rather than in their home country’s debt market.
C
A persistent and positive FX swap basis may exist because of the decision of institutional investors to reduce their hedges of foreign currency investments.
D
A persistent and positive FX swap basis is likely to result from international banks concentrating their lending activities in their home markets and reducing loan exposures in offshore markets.
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