Long-term covered interest parity: evidence from currency swaps (original) (raw)

Currency swaps and long-term covered interest parity

Economics Letters, 1995

The present study employs daily data, as opposed to weekly data used in previous studies, to examine whether long-term covered interest parity holds when a currency swap is used as a hedging instrument. We find that large deviations were not rare during the late 1980s but such deviations have diminished in recent years.

A non-parametric analysis of covered interest parity in long-date capital markets

Journal of International Money and Finance, 1994

The financially innovative currency swap has elevated the international mobility of long-term assets. Of interest is whether the covered interest parity condition now holds in these markets, with the currency swap as the forward-exchange risk hedge. The empirical conclusions presented in the paper suggest that deviations from covered interest parity (in excess of transactions costs) are not rare. Yet, while profit opportunities are not always short-lived, an analysis of the deviations in excess of transactions costs reveals that they diminish over time, and eventually disappear. (JEL F32).

Risk-Adjusted Covered Interest Parity: Theory and Evidence

SSRN Electronic Journal, 2017

We extend the theory of covered interest parity (CIP), aligning the different risks involved in uncollateralized money market transactions and collateralized foreign exchange (FX) swap transactions, which underscore CIP deviations in times of elevated uncertainty. We postulate that the swap dealer behaves as if he tries to filter out the counterparty risk embedded in money market rates in pricing FX swaps. Our results suggest that he does so not only during turbulent times but also under normal market conditions. The extended theory also uncovers a simple way to disentangle counterparty and liquidity risk premiums embedded in money market rates.

Covered Interest Parity, Uncovered Interest Parity and Exchange Rate Dynamics

The Economic Journal, 1983

A number of macroeconomic models of open economies under flexible exchange rate assume a strong version of perfect capital mobility which implies that currency speculation commands no risk premium. If this assumption is dropped a number of important results no longer obtain. First, the exchange rate and interest rate cannot be in steady state unless both the government deficit and current account equal zero, not simply their sum, as would otherwise be the case. Second, even in steady state the domestic interest rate can deviate from the foreign interest rate by an amount which depends upon relative domestic asset supplies. Finally, introducing risk aversion on the part of speculators can reduce the response on impact of the exchange rate to changes in domestic asset supplies. In this sense rational speculators, if they are less risk averse than other agents, can destabi'ize exchange markets.

Uncovered Interest Rate Parity, Carry Trade, and Country Equity Return Differentials

Global Economy Journal, 2018

This paper applies a mixed effect model to investigate the relationship between international equity returns and forward discount sorted currency returns from three base currencies (i. e., US dollar, euro, and pound sterling). Empirical results using the portfolio approach show that high-interest rate currencies co-move positively while low-interest rate currencies co-move negatively, suggesting that foreign equity excess returns can help to explain investment in currency markets, providing a partial resolution to the uncovered interest parity conundrum. Furthermore, we show that global equity market returns, volatility, and liquidity correlate well with currency returns.

The Failure of Uncovered Interest Parity: Is it Near-rationality in the Foreign Exchange Market?

1991

A risk-averse US investor ad-justs the shares of a portfolio of short-term nominal domestic and foreign assets to maximize expected utility. The optimal strategy is to respond immediately to all new information which arrives weekly. We calculate the expected utility foregone when the investor abandons the optimal strategy and instead optimizes less frequently. We also consider the cases where the investor ignores the covariance between returns sourced in different countries, and where the investor makes unsystematic mistakes when forming expectations of exchange rate changes.

Deviations From Covered Interest Rate Parity: Evaluating Drivers for Changes

Journal of Quantitative Methods, 2020

This paper evaluates the deviation from covered interest rate parity (CIP) after the great financial crisis. As a new phenomenon, this deviation has been approached both theoretically (violating the no arbitrage condition) and empirically. Through an extensive literature review, this study maps the possible drivers of the deviation and their proxies. We apply the analysis on a set of countries that are not yet explored in the related literature so far, even though represent a significant part of the foreign exchange market. Regarding the results, a significant weight in the financial drivers is obtained. The result claims for a deeper analysis and opens the possibility to evaluate this phenomenon under a new perspective.

The Uncovered Interest rate Parity- A Literature Review

Interest rates and exchange rates are considered to be one of the most discussed areas in International Finance. When considering the main theories that explore on these two variables, Uncovered Interest Rate Parity (UIP) states that the interest rate differential is an unbiased predictor of the spot exchange rate changes. The impact on investors' attitude is that they would be indifferent towards the returns on domestic and foreign assets denominated in same currency thereby eliminating any short term arbitrage profits. Studies of this nature are of significance in the case of Sri Lanka, as a country which is trade dependent accurate forecasts of exchange rates would be of immense importance. Hence this study focuses on reviewing what is revealed by literature so far and what is not.