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Abstract
This paper examines how asset demand and funding conditions affect exchange rate determination through the corporate basis, defined as the yield differential between currency-hedged corporate bonds issued in U.S. dollars and foreign currencies by the same entity. We propose a three-way decomposition of the corporate basis into a credit spread differential, a convenience yield differential, and the cross-currency basis. These components capture demand for risky dollar credit, demand for safe dollar assets, and dollar funding conditions in foreign exchange swap markets. A simple theoretical framework clarifies the economic forces underlying each component. Corporate bond market liquidity drives the credit spread differential, while convenience benefits and intermediary constraints account for the remaining components. Empirically, risky and safe dollar demand matter for exchange rates, with effects that are state dependent: safe-asset demand dominates during flight-to-safety episodes, whereas risky credit demand becomes more important during periods of large liquidity shocks to bond markets.