Credit Migration and Covered Interest Rate Parity

Liao, Gordon Y.

doi:10.17016/ifdp.2019.1255

Cited by 5 publications

(6 citation statements)

References 50 publications

(82 reference statements)

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“…() model exchange rate policy at the zero lower bound and relate it to CIP deviations. Liao () examines the implications of corporate funding cost arbitrage for CIP deviations. Rime, Schrimpf, and Syrstad () focus on the role of money market segmentation for CIP deviations.…”

mentioning

confidence: 99%

Deviations from Covered Interest Rate Parity

Du¹,

Tepper²,

Verdelhan

2018

The Journal of Finance

444

133

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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.

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confidence: 99%

Deviations from Covered Interest Rate Parity

Du¹,

Tepper²,

Verdelhan

2018

The Journal of Finance

444

133

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“…Other related work on CIP violations after the crisis includes Avdjiev et al. (), Iida, Kimura, and Sudo (), Liao (), and Sushko et al. ().…”

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confidence: 99%

“…Conversely, bond mutual funds can invest in euro‐ or dollar‐denominated bonds but may be prevented by their mandates from trading currency forwards. Liao () links CIP violations to the hedging demand of nonfinancial firms using a segmented‐markets model.…”

mentioning

confidence: 99%

The Dynamics of Financially Constrained Arbitrage

Gromb¹,

Vayanos

2018

The Journal of Finance

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We develop a model in which financially constrained arbitrageurs exploit price discrepancies across segmented markets. We show that the dynamics of arbitrage capital are self‐correcting: following a shock that depletes capital, returns increase, which allows capital to be gradually replenished. Spreads increase more for trades with volatile fundamentals or more time to convergence. Arbitrageurs cut their positions more in those trades, except when volatility concerns the hedgeable component. Financial constraints yield a positive cross‐sectional relationship between spreads/returns and betas with respect to arbitrage capital. Diversification of arbitrageurs across markets induces contagion, but generally lowers arbitrageurs' risk and price volatility.

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“…Examining existing studies analyzing CIP imbalances, substantial results supporting the validity of CIP were reported in research before the Global Financial Crisis (GFC). However, studies analyzing the periods during and after the GFC (2008)(2009) reported that due to factors such as financial regulations, risk aversion, monetary policies, and liquidity constraints, significant CIP deviations occurred (Du et al 2019;Baba et al 2008;Cerutti et al 2020;Liao 2019). When CIP deviations occur due to domestic or international financial shocks, they act as arbitrage incentives for global investors.…”

Section: Introductionmentioning

confidence: 99%

Analysis of Long-Term Bond Yields Using Deviations from Covered Interest Rate Parity

2024

JRFM

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In this study, the impact of arbitrage resulting from Covered Interest Parity (CIP) deviations on Korea’s long-term interest rates was analyzed, utilizing Vector Error Correction (VEC) models for Granger Causality and Impulse Response Function analyses. This analysis covered the period from February 2002 to September 2023, with a comparative analysis of the periods before and after the Global Financial Crisis (GFC). The Granger Causality analysis indicated that changes in the swap basis reflecting CIP deviation presented a significant Granger causal relationship with the variations in domestic long-term interest rates. Notably, in the post-GFC period, when CIP deviations were relatively pronounced, the incentives for arbitrage trading exhibited a stronger leading effect in terms of inducing changes in domestic long-term interest rates. The Impulse Response Function analysis showed that domestic long-term interest rates significantly and negatively responded to the positive shocks in the swap basis. This response was even more pronounced during the period following the GFC. Additionally, foreign long-term interest rates and monetary policy variables also demonstrated a significant impact on domestic long-term interest rates. These findings imply that the adjustment path back to equilibrium from CIP deviations, driven by arbitrage, was developed more through changes in domestic interest rates rather than exchange rate fluctuations, especially after the GFC.

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Credit Migration and Covered Interest Rate Parity

Cited by 5 publications

References 50 publications

Deviations from Covered Interest Rate Parity

Deviations from Covered Interest Rate Parity

The Dynamics of Financially Constrained Arbitrage

Analysis of Long-Term Bond Yields Using Deviations from Covered Interest Rate Parity

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