Gino Cenedese, Pasquale Della Corte, Tianyu Wang, 19 June 2019

Deviations from covered interest parity represent, in theory, an arbitrage opportunity. This column shows that post-crisis, financial regulation may explain why this mispricing persists and cannot be arbitraged away. It also finds that more constrained dealers demand an extra premium from their clients for synthetic dollar funding relative to direct dollar funding, resulting in deviations in covered interest parity.

Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko, 28 September 2016

Covered interest parity is close to a physical law in international finance, yet it has been consistently violated since the Global Crisis. Violations since 2014, once banks had strengthened their balance sheets and regained easy access to funding, are especially puzzling. This column argues that the violation reflects a combination of foreign exchange hedging demand and tighter limits to arbitrage. Hedging demand has been boosted, in particular, by divergent monetary policies in an ultra-low interest rate environment, while tighter limits to arbitrage result from a stricter management of banks’ balance sheets.


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