Covered Interest Parity in long-dated securities

57 Pages Posted: 23 Jun 2020 Last revised: 18 Nov 2020

Date Written: May 29, 2020

Abstract

This paper investigates the validity of Covered Interest Rate Parity (CIP) in long-dated fixed income securities. I show that common measures of CIP in securities of longer maturities rely on trading strategies subject to rollover risk and credit risk, or fail to fully account for the trading costs. Hence, round-trip CIP profit is generally not possible to reap when the trade is risk-free and all costs are taken into account. In particular, short-selling costs (haircuts and lending fees) and differences in funding spreads across currencies allow for substantial deviations from CIP without implying arbitrage opportunities. In contrast to recent research, my results suggest that CIP holds well and lend little support to the view that stricter banking regulations have led to persistent arbitrage opportunities in long-dated fixed income and currency markets.

Keywords: Covered Interest Parity, FX-swaps, Libor, Corporate bonds, Arbitrage, Securities Lending

JEL Classification: E43, F31, G15

Suggested Citation

Syrstad, Olav, Covered Interest Parity in long-dated securities (May 29, 2020). Available at SSRN: https://ssrn.com/abstract=3611635 or http://dx.doi.org/10.2139/ssrn.3611635

Olav Syrstad (Contact Author)

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

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