Working Paper: NBER ID: w28777
Authors: Wenxin Du; Jesse Schreger
Abstract: The covered interest rate parity (CIP) condition is a fundamental arbitrage relationship in international finance. In this chapter, we review its breakdown during the Global Financial Crisis and its continued failure in the subsequent decade. We review how to measure CIP deviations, discuss the drivers of CIP deviations, and the implications of CIP deviations for global financial markets.
Keywords: Covered Interest Rate Parity; CIP Deviations; International Capital Markets; Dollar Funding; Financial Intermediaries
JEL Codes: E00; F00; G00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| breakdown of CIP during the GFC (F65) | increased balance sheet constraints on financial intermediaries (G21) |
| increased balance sheet constraints on financial intermediaries (G21) | limited ability to supply dollar funding (E51) |
| limited ability to supply dollar funding (E51) | deviations from the CIP condition (C62) |
| regulatory reforms (G18) | increased balance sheet constraints on financial intermediaries (G21) |
| deviations from the CIP condition (C62) | higher synthetic dollar interest rate than direct rate (E43) |
| higher synthetic dollar interest rate than direct rate (E43) | affects cost of borrowing globally (F65) |