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Covered Interest Parity in Emerging Markets: Measurement and Drivers

Author

Listed:
  • Mai Dao
  • Pierre-Olivier Gourinchas

Abstract

We study the behavior of Covered Interest Parity (CIP) deviations – aka the CIP basis - in Emerging Markets (EM). A major challenge in computing the CIP basis in EM’s lies in measuring local currency interest rates which are free of local credit risk. To do so, we construct a ‘purified’ CIP basis for eight major EM currencies using supranational bonds issued in EM local currencies and US dollar going back twenty years. We show that this ‘purified’ CIP basis aligns well with theory-implied predictions. In the cross-section and the timeseries, the basis correlates with fundamental forces driving supply and demand for dollar forwards. Shocks to global dollar funding costs, global intermediary’s balance sheet capacity, and the demand for dollar safe assets interact with currency-specific dollar hedging and funding needs in moving the CIP basis in EM’s.

Suggested Citation

  • Mai Dao & Pierre-Olivier Gourinchas, 2025. "Covered Interest Parity in Emerging Markets: Measurement and Drivers," IMF Working Papers 2025/057, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2025/057
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