Working Paper: NBER ID: w30753
Authors: Felipe E. Aldunate; Zhi Da; Borja Larrain; Clemens Sialm
Abstract: Frequent, yet uninformed, fund flows in Chilean pension plans generate substantial trading in currency markets due to the high allocation to international securities. These non-fundamental flows have a significant impact on the Chilean peso, which is estimated to have a relatively low price elasticity of 0.81. Hedging by the banking sector propagates the price pressure to currency forward markets and results in violations of the covered interest rate parity. Using trading data and bank balance sheet data, we confirm that regulatory requirements and banks’ risk bearing constraints create limits of arbitrage.
Keywords: No keywords provided
JEL Codes: F31; F32; F33; G11; G15; G21; G23; G40; G51; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Nonfundamental fund flows from Chilean pension plans (G23) | Chilean peso (N26) |
| Hedging by the banking sector (G21) | Price pressure to currency forward markets (F31) |
| Regulatory requirements and banks' risk-bearing constraints (G28) | Limits to arbitrage (G19) |
| Nonfundamental fund flows from Chilean pension plans (G23) | Price elasticity of demand for Chilean peso (F31) |
| Hedging by the banking sector (G21) | Deviations from CIP (L15) |
| Regulatory constraints and risk-bearing limits on banks (G28) | Incomplete arbitrage (D52) |