Deviations from Covered Interest Rate Parity

We find that deviations from the covered interest rate parity (CIP) condition imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world. Contrary to the common view, these deviations for major currencies are not explained away by credit risk or...

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Bibliographic Details
Published in:The Journal of finance (New York) 2018-06, Vol.73 (3), p.915-957
Main Authors: DU, WENXIN, TEPPER, ALEXANDER, VERDELHAN, ADRIEN
Format: Article
Language:English
Subjects:
Arbitrage
Assets
Credit risk
Economic models
Interest rate parity theorem
Interest rates
Markets
Prices
Transaction costs
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Summary:We find that deviations from the covered interest rate parity (CIP) condition imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world. Contrary to the common view, these deviations for major currencies are not explained away by credit risk or transaction costs. They are particularly strong for forward contracts that appear on banks' balance sheets at the end of the quarter, pointing to a causal effect of banking regulation on asset prices. The CIP deviations also appear significantly correlated with other fixed income spreads and with nominal interest rates.
ISSN:0022-1082
1540-6261
DOI:10.1111/jofi.12620