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Peso-Dollar Forward Market Analysis: Explaining Arbitrage Opportunities during the Financial Crisis

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  • Hernández Juan R.

Abstract

Using a vector error correction model I test whether shocks in the funding liquidity conditions in the U.S. and Europe separately explain deviations from the covered interest parity (CIP) between the U.S. Dollar and the Mexican Peso. I find that: (1) Apparent deviations from the CIP seem to be persistent, unless a closer measure to the true costs of funding for the agents is considered. (2) A stable long-run equilibrium relation emerges when I include the effects of funding liquidity shocks stemming from the U.S. and Europe. (3) The exchange rate forward premium adjusts towards a long-run equilibrium relation given by the CIP. (4) Surprisingly, the yield on 1-month Mexican CETEs has its own stochastic trend despite the strong relation between the U.S. and Mexico's economies. (5) Analysis confirms that both future and spot exchange rates are affected by shocks stemming from the U.S. Treasury Bills, the funding liquidity in the U.S. and Europe, and the Mexican CETEs.

Suggested Citation

  • Hernández Juan R., 2014. "Peso-Dollar Forward Market Analysis: Explaining Arbitrage Opportunities during the Financial Crisis," Working Papers 2014-09, Banco de México.
    • Handle: RePEc:bdm:wpaper:2014-09
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    1. Hernández, Juan R., 2020. "Covered Interest Parity: A Stochastic Volatility Approach to Estimate the Neutral Band," MPRA Paper 100744, University Library of Munich, Germany.
    2. Bush Georgia, 2019. "Bank foreign currency funding and currency markets: the case of Mexico post GFC," Working Papers 2019-01, Banco de México.

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    More about this item

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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