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Risk and Specialization in Covered-Interest Arbitrage

Author

Listed:
  • Tobias J. Moskowitz
  • Chase P. Ross
  • Sharon Y. Ross
  • Kaushik Vasudevan

Abstract

Prevailing theories of financial intermediation assume an integrated financial sector with frictionless risk-sharing. However, we identify substantial risk-sharing frictions linked to intermediary specialization using the cross-section of covered-interest parity (CIP) deviations as a laboratory. Obtaining confidential supervisory data covering $25 trillion in daily bank exposures, we document that CIP arbitrage is risky for banks, which take on maturity mismatches and purchase risky assets to hedge their currency exposure from derivatives. These risks lead intermediaries to specialize in markets where they have expertise in managing them. Our results highlight the importance of intermediary specialization and its impact on risk premia.

Suggested Citation

  • Tobias J. Moskowitz & Chase P. Ross & Sharon Y. Ross & Kaushik Vasudevan, 2024. "Risk and Specialization in Covered-Interest Arbitrage," NBER Working Papers 32707, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:32707
    Note: AP IFM
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    Cited by:

    1. Kubitza, Christian & Sigaux, Jean-David & Vandeweyer, Quentin, 2025. "The implications of CIP deviations for international capital flows," Working Paper Series 3017, European Central Bank.

    More about this item

    JEL classification:

    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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