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Capital Controls and Covered Interest Parity

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  • Takatoshi Ito

Abstract

This paper examines covered interest parity between Yen-denominated and dollar-denominated assets: Euro-yen and Euro-dollar three month deposit rates,and the representative and comparable three-month interest rates in Japan andin the U.S. An objective of this paper is to single out the portion of deviations from covered interest parity that is caused by capital controls imposed by the Japanese authority.To that end, new measures of one-way arbitrage gain are defined taking into account transactions costs associatedwith the bid-ask spread of exchange rates and the transactions tax on repurchase agreements, Gensaki, in Japan. According to our measure, covered interest parity has been holding, as theory predicts, in the Euro market since 1977.The Euro-Yen market must have been thin to have caused violations toparity in 1975 and 1976. Capital controls imposed by the Japanese Government are detected by one-way arbitrage measures between Gensaki in Japan and Euro-Dollar deposits between 1975 and 1980.After a new law was enacted in December 1980 which lifted most capital controls, covered interest parity has been holding between Gensaki and dollar-denominated assets.

Suggested Citation

  • Takatoshi Ito, 1983. "Capital Controls and Covered Interest Parity," NBER Working Papers 1187, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1187
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    1. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-1459, Nov.-Dec..
    2. Frenkel, Jacob A & Levich, Richard M, 1975. "Covered Interest Arbitrage: Unexploited Profits?," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 325-338, April.
    3. John H. Makin, 1984. "A Fiscal Framework for Analysis of Interest Rate Behavior in Open Economies," NBER Working Papers 1355, National Bureau of Economic Research, Inc.
    4. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 370-384, April.
    5. Kenneth Rogoff & Charles Wyplosz, 1999. "International Seminar on Macroeconomics," NBER Books, National Bureau of Economic Research, Inc, number rogo99-1, July.
    6. Deardorff, Alan V, 1979. "One-Way Arbitrage and Its Implications for the Foreign Exchange Markets," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 351-364, April.
    7. Frenkel, Jacob A & Levich, Richard M, 1977. "Transaction Costs and Interest Arbitrage: Tranquil versus Turbulent Periods," Journal of Political Economy, University of Chicago Press, vol. 85(6), pages 1209-1226, December.
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    Cited by:

    1. Daniele Checchi, 1992. "Capital controls and distribution of income: Empirical evidence for Great Britain Japan and Australia," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 128(3), pages 558-587, September.
    2. V. Vance Roley, 1986. "U.S. Monetary Policy Regimes and U.S.-Japan Financial Relations," NBER Working Papers 1858, National Bureau of Economic Research, Inc.
    3. Ajay Shah & Ila Patnaik, 2007. "India's Experience with Capital Flows: The Elusive Quest for a Sustainable Current Account Deficit," NBER Chapters,in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 609-644 National Bureau of Economic Research, Inc.
    4. Barry Eichengreen & Mariko Hatase, 2005. "Can a Rapidly-Growing Export-Oriented Economy Smoothly Exit an Exchange Rate Peg? Lessons for China from Japan's High-Growth Era," NBER Working Papers 11625, National Bureau of Economic Research, Inc.
    5. Ito, Takatoshi & Roley, V. Vance, 1987. "News from the U.S. and Japan : Which moves the yen/dollar exchange rate?," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 255-277, March.
    6. Jeffrey A. Frankel, 1993. "Is Japan Creating a Yen Bloc in East Asia and the Pacific?," NBER Chapters,in: Regionalism and Rivalry: Japan and the United States in Pacific Asia, pages 53-88 National Bureau of Economic Research, Inc.
    7. Takatoshi Ito & V. Vance Roley, 1988. "Intraday Yen/Dollar Exchange Rate Movements: News or Noise?," NBER Working Papers 2703, National Bureau of Economic Research, Inc.
    8. Ito, Takatoshi, 1988. "Use of (Time-Domain) Vector Autoregressions to Test Uncovered Interest Parity," The Review of Economics and Statistics, MIT Press, vol. 70(2), pages 296-305, May.
    9. Makram El-Shagi, 2010. "Capital controls and international interest rate differentials," Applied Economics, Taylor & Francis Journals, vol. 42(6), pages 681-688.
    10. Richard C. Marston, 1992. "Determinants of Shrt-Term Real Interest Differentials Between Japan and the United States," NBER Working Papers 4167, National Bureau of Economic Research, Inc.
    11. Jeffrey A. Frankel & Kenneth A. Froot, 1986. "The Dollar as Speculative Bubble: A Tale of Fundamentalists and Chartists," NBER Working Papers 1854, National Bureau of Economic Research, Inc.
    12. An, Lian & Kim, Yoonbai & You, Yu, 2016. "Floating exchange rates and macroeconomic independence," International Review of Economics & Finance, Elsevier, vol. 42(C), pages 23-35.

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