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Deviations from Covered Interest Parity in the Emerging Markets After the 2008 Global Financial Crisis

Author

Listed:
  • Utku Bora Geyikci
  • Suheyla Ozyildirim

Abstract

In this paper, we examine deviations from covered interest parity (CIP) for six emerging market economies using daily data following the global financial crisis. After documenting large and persistent discrepancies between January 2010 and July 2018, we show the significant role of local factors in explaining sustained deviations from CIP. Specifically, we present evidence that the main drivers of explaining CIP deviations are cost of illiquidity and interest differentials. Our findings suggest that the impact of credit risk on CIP deviations in emerging market economies may take two forms. In low-carry currencies, the well-known mechanism for credit risk operates so that the increase in credit risk exacerbates CIP deviations. Conversely, in high-carry currencies, the high usage of FX swaps makes swap rates react more than domestic rates, which causes CIP to decrease. Finally, global factors play no prominent role in predicting CIP deviations.

Suggested Citation

  • Utku Bora Geyikci & Suheyla Ozyildirim, 2021. "Deviations from Covered Interest Parity in the Emerging Markets After the 2008 Global Financial Crisis," Working Papers 2126, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    • Handle: RePEc:tcb:wpaper:2126
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    File URL: https://www.tcmb.gov.tr/wps/wcm/connect/en/tcmb+en/main+menu/publications/research/working+paperss/2021/21-26
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    More about this item

    Keywords

    Covered interest parity; FX swap; Emerging markets; Financial crisis;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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