Covered interest arbitrage profits: The role of liquidity and credit risk

Covered interest rate parity in emerging markets

“…However Fong, Valente, and Fung (2010) find large numbers of deviations in covered interest rate parity for the Hong Kong Dollar for the short term capital market. They find evidence that most of these deviations are caused by liquidity and credit risk premia yet some violations persist and can be exploited by traders able to negotiate small transaction fees.…”

Limits to Arbitrage During the Crisis: Funding Liquidity Constraints and Covered Interest Parity

“…These are Mitchell, Pedersen, and Pulvino (2007) focusing on the convertible bond market, and, during the recent financial crisis, Mitchell and Pulvino (2011) and Garleanu and Pedersen (2011), both addressing the CDS and bond yield spread. More generally, Brunnermeier (2009) The four that stand out are Taylor (1989), Rhee and Chang (1992), Akram, Rime, and Sarno (2008) and Fong, Valente, and Fung (2010). These papers all use high frequency data, synchronous among the various markets under study, and inclusive of bid-ask spreads as a measure of transaction costs.…”

The solution to the forward-bias puzzle: Reply

“…11 "Once these risk premia are taken into account, small arbitrage profits only accrue to traders who are able to negotiate low trading costs. "Fong et al (2010Fong et al ( , 1098)12 King's objection is essentially the same as Chang's objection mentioned in footnote 1.…”

“…Not only do covered interest parity and Eq. (1) not hold in every possible state of the world, but as Akram et al (2008) and Fong et al (2010) show, in the very short run they often do not hold even in some actual states of the world.…”