The term structure of CIP violations

Mikhail Chernov, Patrick Augustin, Lukas Schmid and Dongho Song

No 14774, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We show theoretically that persistent deviations from covered interest parity (CIP) across multiple horizons imply simultaneous arbitrage opportunities only if uncollateralized interbank lending rates are riskless. In the absence of observable riskless discount rates, we extract them empirically from interest rate swaps using a simple no-arbitrage framework. They deliver novel quantitative benchmarks that reconcile a zero cross-currency basis with non-zero cross-currency basis swap rates. We quantify that the no-arbitrage benchmark, which is consistent with intermediary-based asset pricing paradigms, accounts for about two thirds of the alleged CIP deviations. The residual pricing errors are associated with the limits-to-arbitrage framework.

Keywords: Cip violations; Negative swap rates; Treasury basis; Anomalies; No-arbitrage; Limits to arbitrage (search for similar items in EconPapers)
JEL-codes: C1 E43 E44 G12 H60 (search for similar items in EconPapers)
Date: 2020-05
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (3)

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