Covered interest rate parity, relative funding liquidity and cross-currency repos

Daniel Kohler and Benjamin Müller

No 2019-05, Working Papers from Swiss National Bank

Abstract: Deviations from the covered interest rate parity (CIP) are considerably smaller or even zero when calculated based on a particular set of repo rates, so-called cross-currency repo rates, instead of standard interest rates, such as overnight indexed swap or Interbank Offered rates. We attribute this (partial) solution of the CIP puzzle to the nearly identical risk characteristics of foreign exchange swaps and cross-currency repos: both are virtually devoid of counterparty credit risk but incorporate a relative funding liquidity premium. In practice, CIP deviations can thus be exploited on a truly riskless basis using cross-currency repo transactions, which is not the case for other interest rates.

Keywords: Covered interest rate parity; FX swap market; cross-currency repos; funding (search for similar items in EconPapers)
JEL-codes: E43 F31 G12 G14 G15 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2019
New Economics Papers: this item is included in nep-ifn, nep-mac, nep-mon and nep-opm
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Citations: View citations in EconPapers (1)

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