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Covered interest parity lost: understanding the cross-currency basis

Author

Listed:
  • Claudio Borio
  • Robert Neil McCauley
  • Patrick McGuire
  • Vladyslav Sushko

Abstract

Covered interest parity verges on a physical law in international finance. And yet it has been systematically violated since the Great Financial Crisis. Especially puzzling have been the violations since 2014, even once banks had strengthened their balance sheets and regained easy access to funding. We offer a framework to think about these violations, stressing the combination of hedging demand and tighter limits to arbitrage, which in turn reflect a tighter management of risks and bank balance sheet constraints. We find empirical support for this framework both across currencies and over time.

Suggested Citation

  • Claudio Borio & Robert Neil McCauley & Patrick McGuire & Vladyslav Sushko, 2016. "Covered interest parity lost: understanding the cross-currency basis," BIS Quarterly Review, Bank for International Settlements, September.
  • Handle: RePEc:bis:bisqtr:1609e
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    References listed on IDEAS

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