Dynamics of Market Anomalies and Measurement Errors of Risk-Free Interest Rates

34 Pages Posted: 20 Mar 2017 Last revised: 7 Jun 2017

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Chi-Fai Lo

The Chinese University of Hong Kong

Chin-To Fung

The Chinese University of Hong Kong (CUHK)

Multiple version iconThere are 2 versions of this paper

Date Written: June 7, 2017

Abstract

Two-market anomalies since the 2008 global financial crisis – the widespread failure of covered interest parity (CIP) in foreign exchange swaps and negative 30-year US dollar interest rate swap-Treasury spreads have been challenging for conventional asset pricing models. Using a three-factor non-Gaussian-term structure model for the US Treasuries, an estimated short-rate premium tends to move in tandem with the CIP deviations and negative swap spread. The dynamics between the premium and two-market anomalies are found to be cointegrated, suggesting a long-run equilibrium between them. As the premium is found to be empirically related to demand for Treasuries, including the Fed’s quantitative easing program and demand for safe assets, it may reflect a convenience yield embedded in the yield curve such that the observed Treasury interest rate is lower than the true risk-free interest rate. The anomalies manifest such measurement error as additional spreads on the observed US dollar interest rates for pricing the corresponding instruments, consistent with recent studies that the US dollar and its interest rates play an important role in determining the CIP deviations.

Keywords: covered interest rate parity, swap spreads, Treasuries, term-structure models; safe assets

JEL Classification: F31, G13

Suggested Citation

Hui, Cho-Hoi and Lo, Chi-Fai and Fung, Chin-To, Dynamics of Market Anomalies and Measurement Errors of Risk-Free Interest Rates (June 7, 2017). Available at SSRN: https://ssrn.com/abstract=2934769 or http://dx.doi.org/10.2139/ssrn.2934769

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Chi-Fai Lo

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

Chin-To Fung

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

Register to save articles to
your library

Register

Paper statistics

Downloads
45
Abstract Views
634
PlumX Metrics