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The role of US bank liquidity and regulations in Covered Interest Parity deviations

Author

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  • Bazán-Palomino, Walter
  • Ortiz, Marco
  • Terrones, Marco E.
  • Winkelried, Diego

Abstract

This paper examines how private bank regulation and liquidity provided by the Federal Reserve in the US are related to deviations from the covered interest parity (CIP). We find evidence that the effects of bank liquidity on CIP deviations partially offset those resulting from regulatory changes in a sample of 11 OECD countries over the 2001-2019 period. This finding supports the conjecture that changes in private banks’ liquidity and regulation can significantly affect the cross-currency basis. Interestingly, the effects of liquidity on CIP deviations become more pronounced as bank regulation intensifies, reflecting interaction effects. One implication is that stricter regulations may amplify liquidity-related distortions, thereby increasing CIP deviations.

Suggested Citation

  • Bazán-Palomino, Walter & Ortiz, Marco & Terrones, Marco E. & Winkelried, Diego, 2025. "The role of US bank liquidity and regulations in Covered Interest Parity deviations," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 102(C).
    • Handle: RePEc:eee:intfin:v:102:y:2025:i:c:s1042443125000630
    DOI: 10.1016/j.intfin.2025.102173
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    Keywords

    Cross-currency bases; Covered interest rate parity; Bank regulation; Liquidity;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy

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