Original Sin and Deviations from Covered Interest Parity

46 Pages Posted: 4 Sep 2020 Last revised: 2 Feb 2021

See all articles by Huanhuan Zheng

Huanhuan Zheng

National University of Singapore

Date Written: July 1, 2020

Abstract

Foreign holdings of sovereign debt in emerging markets (EMs) shift from foreign currency (FC) to local currency (LC), especially after the global financial crisis. We show that such a dissipation of original sin enlarges deviations from covered interest rate parity (CIP) in EMs, as FC debt is more important in transmitting global financial cycles to EMs than LC debt. We further provide evidence that FC debt is more efficient in tapering CIP deviations because it bypasses capital controls, circumvents high inflation, weak institution and asymmetric information, and enhances price discovery.

Keywords: covered interest parity, original sin, currency denomination, sovereign debt, capital control

JEL Classification: E43, F38, G15

Suggested Citation

Zheng, Huanhuan, Original Sin and Deviations from Covered Interest Parity (July 1, 2020). Available at SSRN: https://ssrn.com/abstract=3661239 or http://dx.doi.org/10.2139/ssrn.3661239

Huanhuan Zheng (Contact Author)

National University of Singapore ( email )

469C Bukit Timah Rd
NUHS Tower Block Level 7
Singapore, 259772
Singapore

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