renminbi deposits and CDs in Hong Kong SaR surging when the Cnh trades at a premium to the CNY, and vice-versa(Figure 6). The influence of shifts in investor sentiment can also be seen in the correlation between the basis and the renminbi risk reversal- which is an index market sentiment(Figures 7) Figure 6. Correlation of Basis and Renminbi Figure 7. Correlation of Basis and Renminbi Risk Deposits and CDs in Hong Kong SAR Reversal RMB bn 1200 1000 arbitrage band arbitrage bi 642 400 600 Renminbi deposits and CDs in Hong Kong SAR Renminbi risk reversal index(3m)l/ CNY-CNH (left scale) CNY-CNH (left scale Sources: Bloomberg LP and IMF staff estimation. Sources: Bloomberg LP, and IMF staff estimation. 1/ Represents market view of the most likely direction of the spot movement over the next three months To confirm that the influence of these variables( Figures 6 and 7)on the basis is robust we estimate a VaR model to test their statistical significance and control for a range of other variables. The dependent variables in the VAR is the onshore-offshore renminbi differential with the following explanatory variables found to have a statistically significant impact, as reflected in VAR impulse-response functions(see the Annex for technical details) the change in renminbi liquidity as measured by deposits and CDs in Hong Kong SAr (Figure 6) the three-month renminbi risk reversal index(Figure 7) a dummy variable for the opening of new channels for renminbi cross-border flows (see Annex for detailed definitions) a dummy for when the quota is hit on the size of the aggregate net position that Hon Kong Sar banks can square with the clearing bank at onshore rates for trade-related renminbi payments The VaR results confirm that the basis is affected by changes in offshore renminbi liquidity This is the case even when controlling for the endogenity that results from the fact that the arbitrage narrowing the basis also affects offshore liquidity. The results also show that shift 2 The reversal index is defined as the implied volatility for call options minus the implied volatility for put options on the base currency with the same delta. It can be interpreted as the market view of the most likely direction of the spot movement over the next maturity date 88 renminbi deposits and CDs in Hong Kong SAR surging when the CNH trades at a premium to the CNY, and vice-versa (Figure 6). The influence of shifts in investor sentiment can also be seen in the correlation between the basis and the renminbi risk reversal,2 which is an index market sentiment (Figures 7). Figure 6. Correlation of Basis and Renminbi Deposits and CDs in Hong Kong SAR Figure 7. Correlation of Basis and Renminbi Risk Reversal -600 -400 -200 0 200 400 600 800 1000 1200 -40 -20 0 20 40 60 80 10/8 10/10 10/12 11/2 11/4 11/6 11/8 11/10 11/12 12/2 12/4 12/6 12/8 12/10 12/12 Renminbi deposits and CDs in Hong Kong SAR CNY-CNH (left scale) RMB bn pips Shaded area: outside of estimated no￾arbitrage band -600 -400 -200 0 200 400 600 800 1000 1200 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 10/8 10/10 10/12 11/2 11/4 11/6 11/8 11/10 11/12 12/2 12/4 12/6 12/8 12/10 12/12 Renminbi risk reversal index (3m) 1/ CNY-CNH (left scale) % pips Shaded area: outside of estimated no￾arbitrage band Sources: Bloomberg L.P., and IMF staff estimation. Sources: Bloomberg L.P., and IMF staff estimation. 1/ Represents market view of the most likely direction of the spot movement over the next three months. To confirm that the influence of these variables (Figures 6 and 7) on the basis is robust we estimate a VAR model to test their statistical significance and control for a range of other variables. The dependent variables in the VAR is the onshore-offshore renminbi differential; with the following explanatory variables found to have a statistically significant impact, as reflected in VAR impulse-response functions (see the Annex for technical details);  the change in renminbi liquidity as measured by deposits and CDs in Hong Kong SAR (Figure 6);  the three-month renminbi risk reversal index (Figure 7);  A dummy variable for the opening of new channels for renminbi cross-border flows (see Annex for detailed definitions).  A dummy for when the quota is hit on the size of the aggregate net position that Hong Kong SAR banks can square with the clearing bank at onshore rates for trade-related renminbi payments. The VAR results confirm that the basis is affected by changes in offshore renminbi liquidity. This is the case even when controlling for the endogenity that results from the fact that the arbitrage narrowing the basis also affects offshore liquidity. The results also show that shift 2 The reversal index is defined as the implied volatility for call options minus the implied volatility for put options on the base currency with the same delta. It can be interpreted as the market view of the most likely direction of the spot movement over the next maturity date