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Funding Liquidity Risk and Deviations from Interest-Rate Parity During the Financial Crisis of 2007-2009

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Author Info
Cho-Hoi Hui (Research Department, Hong Kong Monetary Authority)
Hans Genberg (Research Department, Hong Kong Monetary Authority)
Tsz-Kin Chung (Research Department, Hong Kong Monetary Authority)

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Abstract

Significant deviations from covered interest parity were observed during the financial crisis of 2007-2009. This paper finds that before the failure of Lehman Brothers the market-wide funding liquidity risk was the main determinant of these deviations in terms of the premiums on swap-implied US dollar interest rates for the euro, British pound, Hong Kong dollar, Japanese yen, Singapore dollar and Swiss Franc. This suggests that the deviations can be explained by the existence and nature of liquidity constraints. After the Lehman default, both counterparty risk and funding liquidity risk in the European economies were the significant determinants of the positive deviations, while the tightened liquidity condition in the US dollar was the main driving factor of the negative deviations in the Hong Kong, Japan and Singapore markets. Federal Reserve Swap lines with other central banks eased the liquidity pressure and reduced the positive deviations in the European economies.

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File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP09_13_full.pdf
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Publisher Info
Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0913.

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Length: 30 pages
Date of creation: Jul 2009
Date of revision:
Handle: RePEc:hkg:wpaper:0913

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Related research
Keywords: Sub-prime crisis; funding liquidity; covered interest parity; FX swaps;

Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

References listed on IDEAS
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    Other versions:
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    Other versions:
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This page was last updated on 2009-11-5.

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