Funding Liquidity Risk and Deviations from Interest-Rate Parity During the Financial Crisis of 2007-2009

Cho-Hoi Hui, Hans Genberg and Tsz-Kin Chung
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Cho-Hoi Hui: Research Department, Hong Kong Monetary Authority
Tsz-Kin Chung: Research Department, Hong Kong Monetary Authority

No 913, Working Papers from Hong Kong Monetary Authority

Abstract: Significant deviations from covered interest parity were observed during the financial crisis of 2007-2009. This paper finds that before the failure of Lehman Brothers the market-wide funding liquidity risk was the main determinant of these deviations in terms of the premiums on swap-implied US dollar interest rates for the euro, British pound, Hong Kong dollar, Japanese yen, Singapore dollar and Swiss Franc. This suggests that the deviations can be explained by the existence and nature of liquidity constraints. After the Lehman default, both counterparty risk and funding liquidity risk in the European economies were the significant determinants of the positive deviations, while the tightened liquidity condition in the US dollar was the main driving factor of the negative deviations in the Hong Kong, Japan and Singapore markets. Federal Reserve Swap lines with other central banks eased the liquidity pressure and reduced the positive deviations in the European economies.

Keywords: Sub-prime crisis; funding liquidity; covered interest parity; FX swaps (search for similar items in EconPapers)
JEL-codes: F31 F32 F33 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2009-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fmk, nep-ifn and nep-sea
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (35)

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Persistent link: https://EconPapers.repec.org/RePEc:hkg:wpaper:0913

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