IDEAS home Printed from https://ideas.repec.org/p/hkm/wpaper/162016.html
   My bibliography  Save this paper

Risk-adjusted Covered Interest Parity: Theory and Evidence

Author

Listed:
  • Alfred Wong

    (Hong Kong Monetary Authority)

  • David Leung

    (Hong Kong Monetary Authority)

  • Calvin Ng

    (Hong Kong Monetary Authority)

Abstract

We extend the theory of covered interest parity (CIP), aligning the different risks involved in uncollateralized money market transactions and collateralized foreign exchange (FX) swap transactions, which underscore CIP deviations in times of elevated uncertainty. We postulate that the swap dealer behaves as if he tries to filter out the counterparty risk embedded in money market rates in pricing FX swaps. Our results suggest that he does so not only during turbulent times but also under normal market conditions. The extended theory also uncovers a simple way to disentangle counterparty and liquidity risk premiums embedded in money market rates.

Suggested Citation

  • Alfred Wong & David Leung & Calvin Ng, 2016. "Risk-adjusted Covered Interest Parity: Theory and Evidence," Working Papers 162016, Hong Kong Institute for Monetary Research.
  • Handle: RePEc:hkm:wpaper:162016
    as

    Download full text from publisher

    File URL: http://hkimr.org/uploads/publication/450/wp-no-16_2016.pdf
    Download Restriction: no

    More about this item

    Keywords

    Covered interest parity; CIP deviation; forward rate; exchange rate; Libor-OIS spread; counterparty credit risk; funding liquidity risk; FX swap;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hkm:wpaper:162016. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (HKIMR). General contact details of provider: http://edirc.repec.org/data/hkimrhk.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.