Economics at your fingertips  

Risk-adjusted Covered Interest Parity: Theory and Evidence

Alfred Wong, David Leung and Calvin Ng
Additional contact information
Alfred Wong: Hong Kong Monetary Authority
David Leung: Hong Kong Monetary Authority
Calvin Ng: Hong Kong Monetary Authority

No 162016, Working Papers from Hong Kong Institute for Monetary Research

Abstract: We extend the theory of covered interest parity (CIP), aligning the different risks involved in uncollateralized money market transactions and collateralized foreign exchange (FX) swap transactions, which underscore CIP deviations in times of elevated uncertainty. We postulate that the swap dealer behaves as if he tries to filter out the counterparty risk embedded in money market rates in pricing FX swaps. Our results suggest that he does so not only during turbulent times but also under normal market conditions. The extended theory also uncovers a simple way to disentangle counterparty and liquidity risk premiums embedded in money market rates.

Keywords: Covered interest parity; CIP deviation; forward rate; exchange rate; Libor-OIS spread; counterparty credit risk; funding liquidity risk; FX swap (search for similar items in EconPapers)
JEL-codes: F31 F32 G15 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2016-08
New Economics Papers: this item is included in nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2) Track citations by RSS feed

Downloads: (external link) (application/pdf)
Our link check indicates that this URL is bad, the error code is: 500 Internal Server Error ( [301 Moved Permanently]--> [301 Moved Permanently]-->

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this paper

More papers in Working Papers from Hong Kong Institute for Monetary Research Contact information at EDIRC.
Bibliographic data for series maintained by HKIMR ().

Page updated 2021-04-07
Handle: RePEc:hkm:wpaper:162016