The Dollar and Deviations from Covered Interest Parity Revisited: New Insights from Dynamic Comovements

28 Pages Posted: 28 Jan 2020

Date Written: October 2019

Abstract

Recent findings that suggest a robust negative association between changes in the cross-currency basis and the broad dollar have taken center stage in the international finance literature. In this article, we revisit this issue, from a purely empirical, data-driven perspective, using G10 and 10 emerging market currencies, and employing dynamic correlations, rather than static correlations, at different rolling windows. Overall, results obtained do not support a consistently negative dynamic relation between changes in the basis and the dollar, even in the post-crisis era, especially at short rolling windows. At the same time, as evidenced by the negative correlations in some historical periods, a negative comovement between changes in the basis and the dollar cannot be fully ruled out, particularly at longer rolling windows. Hence the nature of the relation is dynamic, varying in direction from negative to positive or vice-versa. As such, like nearly everything else in the financial markets, the comovement between changes in the basis and the dollar is anything but directionally static. This result has broader implications for optimal positioning in the cross-currency basis swap markets.

Keywords: Dollar, cross-currency basis swap spreads, rolling correlations

JEL Classification: F31, G11, G15

Suggested Citation

Agudze, Komla and Ibhagui, Oyakhilome and Thompson, Bolarinwa, The Dollar and Deviations from Covered Interest Parity Revisited: New Insights from Dynamic Comovements (October 2019). Available at SSRN: https://ssrn.com/abstract=3513427 or http://dx.doi.org/10.2139/ssrn.3513427

Komla Agudze

Independent ( email )

No Address Available
United States

Oyakhilome Ibhagui (Contact Author)

Independent ( email )

No Address Available
United States

Bolarinwa Thompson

Independent

No Address Available
United States

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