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Credit Migration and Covered Interest Rate Parity

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  • Gordon Y. Liao

Abstract

I document economically large and persistent discrepancies in the pricing of credit risk between corporate bonds denominated in different currencies. This violation of the Law-of-One-Price (LOOP) in credit risk is closely aligned with violations of covered interest rate parity in the time series and the cross-section of currencies. I explain this phenomenon with a model of market segmentation. Post-crisis regulations and intermediary frictions have severely impaired arbitrage in the exchange rate and credit markets each on their own, but capital flows, either currency-hedged investment or debt issuance, bundle together the two LOOP violations. Limits of arbitrage spill over from one market to another.

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  • Gordon Y. Liao, 2016. "Credit Migration and Covered Interest Rate Parity," Working Paper 468601, Harvard University OpenScholar.
  • Handle: RePEc:qsh:wpaper:468601
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    File URL: http://scholar.harvard.edu/gliao/node/468601
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    Cited by:

    1. Malamud, Semyon & Schrimpf, Andreas, 2018. "An Intermediation-Based Model of Exchange Rates," CEPR Discussion Papers 13182, C.E.P.R. Discussion Papers.
    2. Denis Gromb & Dimitri Vayanos, 2018. "The Dynamics of Financially Constrained Arbitrage," Journal of Finance, American Finance Association, vol. 73(4), pages 1713-1750, August.
    3. Robin Greenwood & Annette Vissing-Jorgensen, 2018. "The Impact of Pensions and Insurance on Global Yield Curves," Harvard Business School Working Papers 18-109, Harvard Business School, revised Dec 2018.
    4. Takahiro Hattori, 2017. "Does swap-covered interest parity hold in long-term capital markets after the financial crisis?," Discussion papers ron293, Policy Research Institute, Ministry of Finance Japan.
    5. Ibhagui, Oyakhilome, 2018. "The Monetary Model of CIP Deviations," MPRA Paper 89641, University Library of Munich, Germany.
    6. repec:eee:inecon:v:112:y:2018:i:c:p:167-181 is not listed on IDEAS

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