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Capital Controls and Covered Interest Parity

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  • Takatoshi Ito

Abstract

This paper examines covered interest parity between Yen-denominated and dollar-denominated assets: Euro-yen and Euro-dollar three month deposit rates,and the representative and comparable three-month interest rates in Japan andin the U.S. An objective of this paper is to single out the portion of deviations from covered interest parity that is caused by capital controls imposed by the Japanese authority.To that end, new measures of one-way arbitrage gain are defined taking into account transactions costs associatedwith the bid-ask spread of exchange rates and the transactions tax on repurchase agreements, Gensaki, in Japan. According to our measure, covered interest parity has been holding, as theory predicts, in the Euro market since 1977.The Euro-Yen market must have been thin to have caused violations toparity in 1975 and 1976. Capital controls imposed by the Japanese Government are detected by one-way arbitrage measures between Gensaki in Japan and Euro-Dollar deposits between 1975 and 1980.After a new law was enacted in December 1980 which lifted most capital controls, covered interest parity has been holding between Gensaki and dollar-denominated assets.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1187.

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Date of creation: Aug 1983
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Publication status: published as Ito, Takatoshi. "Capital Controls and Covered Interest Parity Between the Dollar and the Yen," Economic Studies Quarterly, Vol. 37, No. 3, September 1986, pp. 223-241.
Handle: RePEc:nbr:nberwo:1187

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  1. Frenkel, Jacob A & Levich, Richard M, 1977. "Transaction Costs and Interest Arbitrage: Tranquil versus Turbulent Periods," Journal of Political Economy, University of Chicago Press, vol. 85(6), pages 1209-26, December.
  2. Frenkel, Jacob A & Levich, Richard M, 1975. "Covered Interest Arbitrage: Unexploited Profits?," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 325-38, April.
  3. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
  4. Deardorff, Alan V, 1979. "One-Way Arbitrage and Its Implications for the Foreign Exchange Markets," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 351-64, April.
  5. Kenneth Rogoff & Charles Wyplosz, 1999. "International Seminar on Macroeconomics," NBER Books, National Bureau of Economic Research, Inc, number rogo99-1.
  6. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 370-84, April.
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Cited by:
  1. Daniele Checchi, 1992. "Capital controls and distribution of income: Empirical evidence for Great Britain Japan and Australia," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 128(3), pages 558-587, September.
  2. Ito, Takatoshi & Roley, V. Vance, 1987. "News from the U.S. and Japan : Which moves the yen/dollar exchange rate?," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 255-277, March.
  3. Barry Eichengreen & Mariko Hatase, 2005. "Can a Rapidly-Growing Export-Oriented Economy Smoothly Exit an Exchange Rate Peg? Lessons for China from Japan's High-Growth Era," NBER Working Papers 11625, National Bureau of Economic Research, Inc.
  4. Jeffrey A. Frankel., 1993. "Is Japan Creating a Yen Bloc in East Asia and the Pacific?," Center for International and Development Economics Research (CIDER) Working Papers C93-007, University of California at Berkeley.
  5. V. Vance Roley, 1986. "U.S. Monetary Policy Regimes and U.S.-Japan Financial Relations," NBER Working Papers 1858, National Bureau of Economic Research, Inc.
  6. Ito, Takatoshi, 1988. "Use of (Time-Domain) Vector Autoregressions to Test Uncovered Interest Parity," The Review of Economics and Statistics, MIT Press, vol. 70(2), pages 296-305, May.
  7. Takatoshi Ito & V. Vance Roley, 1988. "Intraday yen/dollar exchange rate movements: news or noise?," Research Working Paper 88-07, Federal Reserve Bank of Kansas City.
  8. Jeffrey A. Frankel & Kenneth A. Froot, 1986. "The Dollar as an Irrational Speculative Bubble: A Tale of Fundamentalisists," NBER Working Papers 1854, National Bureau of Economic Research, Inc.
  9. Richard C. Marston, 1992. "Determinants of Shrt-Term Real Interest Differentials Between Japan and the United States," NBER Working Papers 4167, National Bureau of Economic Research, Inc.

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