Capital Controls and the Volatility of the Renminbi Covered Interest Deviation

48 Pages Posted: 3 Dec 2019

See all articles by Zhitao Lin

Zhitao Lin

Jinan University - School of Economics

Xingwang Qian

State University of New York, Buffalo State

Jinzhao Chen

ESC Clermont Business School; Université Clermont Auvergne - Clermont Recherche Management (CleRMa) EUM

Date Written: November 18, 2019

Abstract

Abstract: We examine how China’s capital controls affect the volatility of the renminbi (RMB) covered interest deviation (CID). We find that capital controls not only drive up the level of the RMB CID, but also cause the CID to be more volatile, highlighting the tradeoff between the role of capital controls in maintaining financial stability and hindering financial market efficiency. We also find that capital controls result in greater CID volatility in more liberalized RMB exchange regimes. Furthermore, we decompose CID into the interest rate differential (IRD) and forward premium (FP) and find that capital controls normally amplify the volatility of both. However, during the Federal Reserve Bank’s quantitative ease era, capital controls mitigated the volatility of the IRD. Finally, using an error correction model, which enables us to study the association of capital controls with both long-run and short-run volatility simultaneously, we find that, while capital controls increase both the long- and short-run volatility of the IRD and the CID overall, they do not affect FP volatility.

Keywords: Capital controls, Covered interest deviation, CID volatility, Interest rate differential, RMB forward premium

JEL Classification: E43, F31, G15

Suggested Citation

Lin, Zhitao and Qian, Xingwang and Chen, Jinzhao, Capital Controls and the Volatility of the Renminbi Covered Interest Deviation (November 18, 2019). Available at SSRN: https://ssrn.com/abstract=3489073 or http://dx.doi.org/10.2139/ssrn.3489073

Zhitao Lin (Contact Author)

Jinan University - School of Economics ( email )

Huang Pu Da Dao Xi 601, Tian He District
Guangzhou, Guangdong 510632
China

Xingwang Qian

State University of New York, Buffalo State ( email )

Classroom BLDG B232
1300 Elmwood Ave
Buffalo, NY 14222
United States
716-878-6031 (Phone)
716-878-6907 (Fax)

Jinzhao Chen

ESC Clermont Business School ( email )

4 Bd Trudaine, Clermont-Ferrand
Clermont-Ferrand, 63000
France

Université Clermont Auvergne - Clermont Recherche Management (CleRMa) EUM ( email )

France

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