Does the covered interest rate parity fit for China?

Chi-Wei Su, Kai-Hua Wang, Ran Tao and Oana-Ramona Lobonţ

Economic Research-Ekonomska Istraživanja, 2019, vol. 32, issue 1, 2009-2027

Abstract: This paper aims to investigate whether the covered interest rate parity (C.I.P.) holds or not through examining the dynamic link between nominal interest rate differential (N.I.R.D.) and nominal exchange rate (N.E.R.) in China. With economic transitions and structural changes existing, we find that the C.I.P. condition using full-sample data does not always hold. Consequently, we apply a time-varying rolling-window approach to revisiting the dynamic causal relationship, and the results show that N.I.R.D. has both positive and negative impacts on N.E.R. in several sub-periods, and in turn, N.E.R. has the same effects on N.I.R.D. for China. Exchange regime reform, currency-specific market risk and capital control are considered in explaining the deviations in some sub-sample periods. Therefore, empirical results have important implications for distinguishing factors that bring about the C.I.P. deviations and further offers policy suggestions for the Chinese monetary authority.

Date: 2019
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DOI: 10.1080/1331677X.2019.1642780

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