This paper identifies a new currency risk stemming from time-varying linkages among option-based currency volatilities. The network strategy buying net-receivers and selling net-transmitters of transitory shocks to currency volatilities generates significant excess returns. Intuitively, net-receivers are exposed to volatility spillovers and compensate investors with higher average returns. In turn, net-transmitters are resilient to volatility transmission and offer a lower risk premium because they hedge against volatility interdependencies in the foreign exchange market. When volatility linkages are controlled for contemporaneous correlations, the network portfolio is uncorrelated with popular benchmarks. Also, the volatility network factor is priced in a broad currency cross-section.

In this paper we investigate the price, volatility and micro-level effects of central bank swap lines during the 2020 pandemic. These policies lowered the ceiling on covered interest rate parity violations and reduced volatility following settlement of swap line auctions. We then combine dealer-level dollar repo auctions by the Bank of England with a trade repository that includes the universe of FX forward and swap contracts traded in the UK. We find evidence of a substitution channel: dealers that draw on swap lines reduce their demand for dollars at the forward leg in the FX market. We also find evidence that dealers that draw on swap lines increased their net supply of dollars to non-financial institutions, supporting the rationale for swap lines in providing cross-border liquidity to the real economy.