Deviations from Covered Interest Rate Parity and the Dollar Funding of Global Banks

Tomoyuki Iida, Takeshi Kimura and Nao Sudo
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Tomoyuki Iida: Bank of Japan

International Journal of Central Banking, 2018, vol. 14, issue 4, 275-325

Abstract: By developing an equilibrium model of the FX swap market, this paper studies the determinants of deviations from covered interest rate parity (CIP) and investigates how changes in the environment surrounding the FX swap market affect the U.S. dollar funding of global banks. We find that the role of global banks' creditworthiness in determining CIP deviations has been supplanted by global interest rate differentials, which reflect monetary policy divergence among advanced economies. Our model and an empirical analysis suggest that the sensitivity of CIP deviations to variation in global interest rate differentials has risen, as regulatory reforms have increased the marginal cost of global banks' dollar funding. We also show that real money investors have increased their presence as suppliers of U.S. dollars in the FX swap market and their investment behavior has significantly affected CIP deviations and hence the dollar funding of global banks.

JEL-codes: F39 G15 G18 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2018:q:3:a:7

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