Covered Interest Parity in Emerging Markets: Measurement and Drivers

Mai Chi Dao and Pierre-Olivier Gourinchas

No 20927, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study the behavior of Covered Interest Parity (CIP) deviations – aka the CIP basis - in Emerging Markets (EM). A major challenge in computing the CIP basis in EM’s lies in measuring local currency interest rates which are free of local credit risk. To do so, we construct a ‘purified’ CIP basis for eight major EM currencies using supranational bonds issued in EM local currencies and US dollar going back twenty years. We show that this ‘purified’ CIP basis aligns well with theory-implied predictions. In the cross-section and the time-series, the basis correlates with fundamental forces driving supply and demand for dollar forwards. Shocks to global dollar funding costs, global intermediary’s balance sheet capacity, and the demand for dollar safe assets interact with currency-specific dollar hedging and funding needs in moving the CIP basis in EM’s.

Keywords: Emerging; markets (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2025-12
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