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Capital Controls and Covered Interest Parity

  • Takatoshi Ito

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.

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File URL: http://www.nber.org/papers/w1187.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1187.

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Date of creation: Aug 1983
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Publication status: published as Ito, Takatoshi. "Capital Controls and Covered Interest Parity Between the Dollar and the Yen," Economic Studies Quarterly, Vol. 37, No. 3, September 1986, pp. 223-241.
Handle: RePEc:nbr:nberwo:1187
Note: ME
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  1. Kenneth Rogoff & Charles Wyplosz, 1999. "International Seminar on Macroeconomics," NBER Books, National Bureau of Economic Research, Inc, number rogo99-1, May.
  2. 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 370-84, April.
  3. 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 351-64, April.
  4. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
  5. Frenkel, Jacob A & Levich, Richard M, 1975. "Covered Interest Arbitrage: Unexploited Profits?," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 325-38, April.
  6. 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 1209-26, December.
  7. 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.
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