Working Paper: NBER ID: w1187
Authors: Takatoshi Ito
Abstract: This paper examines covered interest parity between Yen-denominated and dollar-denominated assets: Euro-yen and Euro-dollar three month deposit rates,and the representative and comparable three-month interest rates in Japan andin the U.S. An objective of this paper is to single out the portion of deviations from covered interest parity that is caused by capital controls imposed by the Japanese authority.To that end, new measures of one-way arbitrage gain are defined taking into account transactions costs associatedwith the bid-ask spread of exchange rates and the transactions tax on repurchase agreements, Gensaki, in Japan. According to our measure, covered interest parity has been holding, as theory predicts, in the Euro market since 1977.The Euro-Yen market must have been thin to have caused violations toparity in 1975 and 1976. Capital controls imposed by the Japanese Government are detected by one-way arbitrage measures between Gensaki in Japan and Euro-Dollar deposits between 1975 and 1980.After a new law was enacted in December 1980 which lifted most capital controls, covered interest parity has been holding between Gensaki and dollar-denominated assets.
Keywords: capital controls; covered interest parity; arbitrage; financial markets; Japan
JEL Codes: F31; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital controls (F38) | covered interest parity (F31) |
| deviations from parity (J79) | capital controls (F38) |
| deregulation in December 1980 (L51) | covered interest parity (F31) |
| capital controls (F38) | deviations from parity (J79) |
| thin euro-yen market (G15) | deviations from parity (J79) |
| capital controls preventing non-residents from purchasing gensaki (F38) | substantial arbitrage gains (G19) |