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Wider Covered Interest Parity Deviations and Lower Stock Returns: Evidence from the Eurozone

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  • Ibhagui, Oyakhilome

Abstract

Financial economists have in recent times begun to analyze the reasons for and determinants of the non-zero cross-currency basis swap spread, a measure of the extent of deviations from covered interest parity (CIP) and risk-less arbitrage. They have however not examined the potential effects of the basis on the market performance of major asset classes, particularly the riskiest asset class – stocks – and how stock markets behave in response to changes in the basis. This paper addresses this question by examining how stock returns in the eurozone respond to changes in and shocks to the euro cross-currency basis. Our results show that there is a positive relationship between changes in the basis and stock market returns. Wider deviations from CIP go pari-passu with declines in stock returns, especially for the long-end basis. The relationship is strongest and most significant during periods of crisis but is generally preserved across the whole sample period. Although the effect of global risk sentiment, proxied by the VIX, on returns is generally the strongest, we show that the positive relation between stock returns and changes in the basis is preserved even after controlling for VIX, dollar exchange rate and other stock-return drivers.

Suggested Citation

  • Ibhagui, Oyakhilome, 2019. "Wider Covered Interest Parity Deviations and Lower Stock Returns: Evidence from the Eurozone," MPRA Paper 92363, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:92363
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    References listed on IDEAS

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    Cited by:

    1. Kenny S, Victoria, 2019. "Effects of Human Capital Investment on Unemployment Volatility in Nigeria (1981-2015)," MPRA Paper 93295, University Library of Munich, Germany.
    2. Kenny S, Victoria, 2019. "Macroeconomic Performance Indicators and Exchange Rate Misalignment in Nigeria," MPRA Paper 93292, University Library of Munich, Germany.
    3. Oyakhilome Ibhagui, 2021. "Inflation differential as a driver of cross-currency basis swap spreads," The European Journal of Finance, Taylor & Francis Journals, vol. 27(6), pages 510-536, April.
    4. Kenny S, Victoria, 2019. "Challenges of female entrepreneurship in Nigeria," MPRA Paper 93166, University Library of Munich, Germany.
    5. Kenny S, Victoria, 2019. "The role of agricultural sector performance on economic growth in Nigeria," MPRA Paper 93132, University Library of Munich, Germany.
    6. Kenny S, Victoria, 2019. "The Role of Public Sector Enterprise on Economic Development: A Case Study Of The Nigerian Power Sector (1981-2015)," MPRA Paper 93291, University Library of Munich, Germany.
    7. Kenny S, Victoria, 2019. "Exchange Rate Management and Economic Growth: An FMOLS Approach," MPRA Paper 93125, University Library of Munich, Germany.
    8. Kenny S, Victoria, 2019. "Determinants of Manufacturing Sector Performance and Its Contribution To Gross Domestic Product In Nigeria," MPRA Paper 93293, University Library of Munich, Germany.
    9. Aipoh, Godwin, 2019. "Comparative analysis of government spending, external debt, domestic credit to private sector, exchange rate and net investment to non-financial companies," MPRA Paper 92874, University Library of Munich, Germany.
    10. Kenny S, Victoria, 2019. "Manufacturing Sector Performance, Exchange Rate Volatility and Inclusive Growth In Nigeria (1981-2015)," MPRA Paper 93296, University Library of Munich, Germany.
    11. Victoria S, Kenny, 2019. "Effect of Foreign Direct Investment and Economic Growth in Nigeria," MPRA Paper 92873, University Library of Munich, Germany.
    12. Kenny S, Victoria, 2019. "A causal relationship between unemployment and economic growth," MPRA Paper 93133, University Library of Munich, Germany.
    13. Kenny S, Victoria, 2019. "Employee productivity and organizational performance: A theoretical perspective," MPRA Paper 93294, University Library of Munich, Germany.
    14. Beini Guo & Oyakhilome Ibhagui, 2019. "China–Africa stock market linkages and the global financial crisis," Journal of Asset Management, Palgrave Macmillan, vol. 20(4), pages 301-316, July.

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    More about this item

    Keywords

    Cross-currency basis; stock market returns; exchange rates and risk sentiment;
    All these keywords.

    JEL classification:

    • F0 - International Economics - - General
    • G0 - Financial Economics - - General

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