Covered Interest Rate Parity Deviations In External Emerging Market Sovereign Debt

11 Pages Posted: 12 Sep 2019

See all articles by Jonathan Hartley

Jonathan Hartley

Harvard University, Harvard Kennedy School (HKS), Students

Date Written: September 1, 2019

Abstract

Non-U.S. dollar denominated external emerging market debt issuance in euros, yen, and sterling has grown substantially in recent years. This paper is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. Such mispricing in the post-Great Recession era creates arbitrage opportunities for investors and suggests that emerging market country policymakers could create fiscal savings by instead more cheaply issuing external sovereign debt in dollars (versus non-dollar developed world currencies like euro, yen, and sterling) and swapping the proceeds to non-dollar currencies with currency forward and spot transactions. Such hypothetical fiscal savings from switching to dollar funding collectively are estimated to be more than $1 billion annually.

Keywords: Behavioral Finance, Exchange Rates, Fixed Income, Arbitrage, Dollar Funding, Government Debt Management

JEL Classification: E43, F31, G15, G28, G40, H63

Suggested Citation

Hartley, Jonathan, Covered Interest Rate Parity Deviations In External Emerging Market Sovereign Debt (September 1, 2019). Available at SSRN: https://ssrn.com/abstract=3446439

Jonathan Hartley (Contact Author)

Harvard University, Harvard Kennedy School (HKS), Students ( email )

Cambridge, MA
United States

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