Uncovering Covered Interest Parity: The Role of Bank Regulation and Monetary Policy

41 Pages Posted: 24 Jul 2017 Last revised: 30 Aug 2017

See all articles by Falk Bräuning

Falk Bräuning

Federal Reserve Banks - Federal Reserve Bank of Boston

Kovid Puria

Federal Reserve Bank of Boston

Date Written: 2017-06-01

Abstract

We analyze the factors underlying the recent deviations from covered interest parity. We show that these deviations can be explained by tighter post-crisis bank capital regulations that made the provision of foreign exchange swaps more costly. Moreover, the recent monetary policy and related interest rate divergence between the United States and other major foreign countries has led to a surge in demand for swapping low interest rate currencies into the U.S. dollar. Given the higher bank balance sheet costs resulting from these regulatory changes, the increased demand for U.S. dollars in the swap market could not be supplied at a constant price, thereby amplifying violations of covered interest parity. Furthermore, we show that dollar swap line agreements existing between the Federal Reserve and foreign central banks mitigate pressure in the swap market. However, the current conditions that govern the provision of dollar funding through foreign central banks are not favorable enough to reduce deviations from covered interest parity to zero.

Keywords: covered interest parity, banking, monetary policy

JEL Classification: E52, F31, G15, G18, G2

Suggested Citation

Bräuning, Falk and Puria, Kovid, Uncovering Covered Interest Parity: The Role of Bank Regulation and Monetary Policy (2017-06-01). Federal Reserve Bank of Boston Research Paper Series Current Policy Perspectives Paper No. 17-3. Available at SSRN: https://ssrn.com/abstract=3007033

Falk Bräuning (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Kovid Puria

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
58
rank
354,541
Abstract Views
323
PlumX Metrics