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Credit migration and covered interest rate parity

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  • Liao, Gordon Y.

Abstract

This paper examines the joint determination of deviations in long-term covered interest rate parity and differences in the credit spread of bonds of similar risk but different currency denomination. These two pricing anomalies are highly aligned in both the time series and the cross-section of currencies. The sum of these two pricing deviations—the corporate basis—represents the currency-hedged borrowing cost difference between currency regions and explains up to a third of the variation in the aggregate corporate debt issuance flow. I show that arbitrage aimed at exploiting one type of security anomaly can give rise to the other.

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  • Liao, Gordon Y., 2020. "Credit migration and covered interest rate parity," Journal of Financial Economics, Elsevier, vol. 138(2), pages 504-525.
    • Handle: RePEc:eee:jfinec:v:138:y:2020:i:2:p:504-525
    DOI: 10.1016/j.jfineco.2020.06.002
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    More about this item

    Keywords

    Covered interest rate parity; Credit spread; Debt issuance; Foreign exchange rate hedging; Limits of arbitrage;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F3 - International Economics - - International Finance
    • F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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