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Deviations from Covered Interest Rate Parity and the Dollar Funding of Global Banks

Author

Listed:
  • Tomoyuki Iida

    (Bank of Japan)

  • Takeshi Kimura

    (Bank of Japan)

  • Nao Sudo

    (Bank of Japan)

Abstract

By developing an equilibrium model of the FX swap market, this paper studies the determinants of deviations from covered interest rate parity (CIP) and investigates how changes in the environment surrounding the FX swap market affect the U.S. dollar funding of global banks. We find that the role of global banks' creditworthiness in determining CIP deviations has been supplanted by global interest rate differentials, which reflect monetary policy divergence among advanced economies. Our model and an empirical analysis suggest that the sensitivity of CIP deviations to variation in global interest rate differentials has risen, as regulatory reforms have increased the marginal cost of global banks' dollar funding. We also show that real money investors have increased their presence as suppliers of U.S. dollars in the FX swap market and their investment behavior has significantly affected CIP deviations and hence the dollar funding of global banks.

Suggested Citation

  • Tomoyuki Iida & Takeshi Kimura & Nao Sudo, 2018. "Deviations from Covered Interest Rate Parity and the Dollar Funding of Global Banks," International Journal of Central Banking, International Journal of Central Banking, vol. 14(4), pages 275-325, September.
    • Handle: RePEc:ijc:ijcjou:y:2018:q:3:a:7
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    Citations

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    Cited by:

    1. Mr. Tobias Adrian & Peichu Xie, 2020. "The Non-U.S. Bank Demand for U.S. Dollar Assets," IMF Working Papers 2020/101, International Monetary Fund.
    2. Torsten Ehlers & Mathias Hoffmann & Alexander Raabe, 2020. "Non-US global banks and dollar (co-)dependence: how housing markets became internationally synchronized," BIS Working Papers 897, Bank for International Settlements.
    3. Aldasoro, Iñaki & Ehlers, Torsten & Eren, Egemen, 2022. "Global banks, dollar funding, and regulation," Journal of International Economics, Elsevier, vol. 137(C).
    4. Krohn, Ingomar & Sushko, Vladyslav, 2022. "FX spot and swap market liquidity spillovers," Journal of International Money and Finance, Elsevier, vol. 120(C).
    5. Syrstad, Olav & Viswanath-Natraj, Ganesh, 2022. "Price-setting in the foreign exchange swap market: Evidence from order flow," Journal of Financial Economics, Elsevier, vol. 146(1), pages 119-142.
    6. Dagfinn Rime & Andreas Schrimpf & Olav Syrstad, 2022. "Covered Interest Parity Arbitrage," Review of Financial Studies, Society for Financial Studies, vol. 35(11), pages 5185-5227.
    7. Dušan Staniek, . "Cross-Currency Basis Spread and Its Impact on Corporate Lending Rates in the Czech Banking Sector," Prague Economic Papers, Prague University of Economics and Business, vol. 0.
    8. Ferrara, Gerardo & Mueller, Philippe & Viswanath-Natraj, Ganesh & Wang, Junxuan, 2022. "Central bank swap lines: micro-level evidence," Bank of England working papers 977, Bank of England.
    9. Ibhagui, Oyakhilome, 2021. "How do sovereign risk, equity and foreign exchange derivatives markets interact?," Economic Modelling, Elsevier, vol. 97(C), pages 58-78.
    10. Sevgi Coşkun & Oyakhilome Ibhagui, 2022. "Technology shocks and covered interest parity deviations in emerging market economies," Empirical Economics, Springer, vol. 63(3), pages 1337-1374, September.
    11. Pēteris Kloks & Patrick McGuire & Angelo Ranaldo & Vladyslav Sushko, 2023. "Bank positions in FX swaps: insights from CLS," BIS Quarterly Review, Bank for International Settlements, September.

    More about this item

    JEL classification:

    • F39 - International Economics - - International Finance - - - Other
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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