Arbitraging Covered Interest Rate Parity Deviations and Bank Lending

Lorena Keller

American Economic Review, 2024, vol. 114, issue 9, 2633-67

Abstract: I propose and test a new channel through which covered interest rate parity (CIP) deviations can affect bank lending in emerging economies. I argue that when CIP deviations exist, banks attempt to arbitrage them. To do so, banks must borrow in a particular currency. When this currency is scarce, bank lending in the currency required to arbitrage decreases, while they use this currency in their arbitrage activities. I test this channel by exploiting differences in the abilities of Peruvian banks to arbitrage CIP deviations. I find evidence that supports the proposed channel.

JEL-codes: F31 G01 G13 G21 O16 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1257/aer.20230425

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