Collateral-Adjusted CIP Arbitrages
64 Pages Posted: 15 Jul 2020 Last revised: 17 May 2021
Date Written: September 30, 2017
I show that an important no-arbitrage consistent but costly collateral rental yield contributes to about two-thirds of the standard CIP violations. I measure this yield using two approaches applied to short- and long-term CIP horizons. First, I assume that the yield is observable and proxy it with the difference between risk-free and overnight index swap rates between bilateral currencies. Second, I assume that the yield is unobservable and generate it using a model incorporating collateralization. Further, this yield appears to be related to global risks and intermediaries’ frictions pointing to an important collateral transmission channel contributing to standard CIP violations.
Keywords: No-Arbitrage, CIP Violation, CSA (ISDA Collateral Support Annex), Funding Rates, Discounting Rates, Collateralization, Collateral Rental Yield, MtM (Mark-to-Market)
JEL Classification: G15, C33, C4, F31, G12, G13, E43
Suggested Citation: Suggested Citation