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Transactions Costs and Covered Interest Arbitrage: Theory and Evidence

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Clinton, Kevin

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Abstract

The extent to which deviations from covered interest parity can be attributed to transactions costs has been exa ggerated in the economic literature because the swap market in foreig n exchange has been ignored. It is shown that such deviations should be no greater than the lowest of the transactions costs in one of thr ee markets: the swap market or either of the two relevant securities markets. This reconciles the theory with the data, which show spreads of no more than a few basis points. However, the empirical results h ave no direct bearing on the conventional market efficiency hypothesi s. Copyright 1988 by University of Chicago Press.

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Publisher Info
Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 96 (1988)
Issue (Month): 2 (April)
Pages: 358-70
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Handle: RePEc:ucp:jpolec:v:96:y:1988:i:2:p:358-70

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  1. Eijffinger, S.C.W. & Huizinga, H.P. & Lemmen, J.J.G., 1996. "Short-term and long-term government debt and nonresident interest witholding taxes," Discussion Paper 88, Tilburg University, Center for Economic Research. [Downloadable!]
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  2. Richard C. Marston, 1992. "Interest Differentials Under Fixed and Flexible Exchange Rates: The Effects of Capital Controls and Exchange Risk," NBER Working Papers 4053, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Flôres Junior, Renato Galvão & Araújo, Carlos Hamilton Vasconcelos, 2002. "Foreign funding to an emerging market: the Monetary Premium Theory and the Brazilian Case, 1991 - 1998," Economics Working Papers (Ensaios Economicos da EPGE) 459, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  4. Pasricha, Gurnain, 2007. "Financial Integration in Emerging Market Economies," MPRA Paper 5278, University Library of Munich, Germany. [Downloadable!]
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  5. Mark Holmes & Yangru Wu, 1997. "Capital controls and covered interest parity in the EU: Evidence from a panel-data unit root test," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 133(1), pages 76-89, March. [Downloadable!] (restricted)
  6. Daniel L. Thornton, 1989. "Tests of covered interest rate parity," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 55-66. [Downloadable!]
  7. Amir Kia, 1996. "Overnight Covered Interest Parity: Theory And Practice," International Economic Journal, Korean International Economic Association, vol. 10(1), pages 59-82, April. [Downloadable!] (restricted)
  8. D. K. Ghosh, 1997. "Arbitrage with hedging by forward contracts: exploited and exploitable profits," European Journal of Finance, Taylor and Francis Journals, vol. 3(4), pages 349-361, December. [Downloadable!] (restricted)
  9. Rosita P. Chang & Sang-Hyop Lee & Sean F. Reid & S. Ghon Rhee, 2002. "One-Way Arbitrage-Based Interest Parity," Tinbergen Institute Discussion Papers 02-115/2, Tinbergen Institute. [Downloadable!]
  10. Burnside, A Craig & Eichenbaum, Martin & Kleshchelski, Isaac & Rebelo, Sérgio, 2006. "The Returns to Currency Speculation," CEPR Discussion Papers 5883, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  11. Maurice Obstfeld & Alan M. Taylor, 2003. "Globalization and Capital Markets," NBER Chapters, in: Globalization in Historical Perspective, pages 121-188 National Bureau of Economic Research, Inc. [Downloadable!]
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  12. A. Craig Burnside & Martin S. Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2008. "Do Peso Problems Explain the Returns to the Carry Trade?," NBER Working Papers 14054, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Akram, Qaisar Farooq & Rime, Dagfinn & Sarno, Lucio, 2008. "Arbitrage in the Foreign Exchange Market: Turning on the Microscope," CEPR Discussion Papers 6878, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  14. Sergio L. Schmukler & Luis Serven, 2002. "Pricing Currency Risk: Facts and Puzzles from Currency Boards," NBER Working Papers 9047, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Kees G. Koedijk & Mack Ott, 1987. "Risk aversion, efficient markets and the forward exchange rate," Review, Federal Reserve Bank of St. Louis, issue Dec, pages 5-13. [Downloadable!]
  16. Charles van Marrewijk, 2004. "An introduction to international money and foreign exchange markets," International Finance 0410006, EconWPA. [Downloadable!]
  17. Bertrand BLANCHETON (CMHE-IFReDE-GRES) & Samuel MAVEYRAUD-TRICOIRE (Université Bordeaux IV), 2006. "The indicators of international financial integration: A set of convergent measures (In French)," Cahiers du GRES 2006-13, Groupement de Recherches Economiques et Sociales. [Downloadable!]
  18. Cho-Hoi Hui & Hans Genberg & Tsz-Kin Chung, 2009. "Funding Liquidity Risk and Deviations from Interest-Rate Parity During the Financial Crisis of 2007-2009," Working Papers 0913, Hong Kong Monetary Authority. [Downloadable!]
  19. Alex Maynard & Peter C. B. Phillips, 2001. "Rethinking an old empirical puzzle: econometric evidence on the forward discount anomaly," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 16(6), pages 671-708. [Downloadable!]
  20. Christian Dreger & Christian Schumacher, 2003. "Are Real Interest Rates Cointegrated? Further evidence based on paneleconometric methods," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 139(I), pages 41-53, March. [Downloadable!]
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