Working Paper: NBER ID: w23170
Authors: Wenxin Du; Alexander Tepper; Adrien Verdelhan
Abstract: We find that deviations from the covered interest rate parity condition (CIP) 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 the 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.
Keywords: No keywords provided
JEL Codes: F31; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CIP deviations (L15) | Arbitrage opportunities (G13) |
| Banking regulation (G28) | Asset prices (G19) |
| Shadow costs of banks' balance sheets (F65) | CIP deviations (L15) |
| CIP deviations (L15) | Fixed-income spreads (G12) |
| CIP deviations (L15) | Nominal interest rates (E43) |
| Banking regulation (G28) | CIP deviations (L15) |
| CIP deviations increase (L15) | Balance sheet constraints for banks (G21) |
| Regulatory filings (G18) | Short-term arbitrage opportunities (G19) |