Deviations from Covered Interest Rate Parity

83 Pages Posted: 25 Apr 2016 Last revised: 28 Jan 2017

Wenxin Du

Federal Reserve Board

Alexander Tepper

Federal Reserve Bank of New York

Adrien Verdelhan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2016

Abstract

We find that deviations from the covered interest rate parity condition (CIP) imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world. Contrary to the common view, these deviations for major currencies are not explained away by credit risk or transaction costs. They are particularly strong for forward contracts that appear on the banks' balance sheets at the end of the quarter, pointing to a causal effect of banking regulation on asset prices. The CIP deviations also appear significantly correlated with other fixed-income spreads and with nominal interest rates.

Keywords: exchange rates, currency swaps, dollar funding

JEL Classification: E43, F31, G15

Suggested Citation

Du, Wenxin and Tepper, Alexander and Verdelhan, Adrien, Deviations from Covered Interest Rate Parity (January 1, 2016). Available at SSRN: https://ssrn.com/abstract=2768207

Wenxin Du

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Alexander Tepper

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Adrien Verdelhan (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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