The Term Structure of Cip Violations

52 Pages Posted: 28 May 2020 Last revised: 11 Feb 2021

See all articles by Patrick Augustin

Patrick Augustin

McGill University

Mikhail Chernov

UCLA Anderson

Lukas Schmid

University of Southern California - Marshall School of Business

Dongho Song

Johns Hopkins University - Carey Business School

Multiple version iconThere are 2 versions of this paper

Date Written: May 2020

Abstract

We show theoretically that persistent deviations from covered interest parity (CIP) across multiple horizons imply simultaneous arbitrage opportunities only if uncollateralized interbank lending rates are riskless. In the absence of observable riskless discount rates, we extract them empirically from interest rate swaps using a simple no-arbitrage framework. They deliver novel quantitative benchmarks that reconcile a zero cross-currency basis with non-zero cross-currency basis swap rates. We quantify that the no-arbitrage benchmark, which is consistent with intermediary-based asset pricing paradigms, accounts for about two thirds of the alleged CIP deviations. The residual pricing errors are associated with the limits-to-arbitrage framework.

JEL Classification: C1, E43, E44, G12, H60

Suggested Citation

Augustin, Patrick and Chernov, Mikhail and Schmid, Lukas and Song, Dongho, The Term Structure of Cip Violations (May 2020). CEPR Discussion Paper No. DP14774, Available at SSRN: https://ssrn.com/abstract=3612842

Patrick Augustin (Contact Author)

McGill University ( email )

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Montreal, Quebec H3A 1G5
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HOME PAGE: http://https://patrickaugustin.ca/

Mikhail Chernov

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Lukas Schmid

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

Dongho Song

Johns Hopkins University - Carey Business School ( email )

Baltimore, MD 20036-1984
United States

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