The Term Structure of Covered Interest Rate Parity Violations

Patrick Augustin (), Mikhail Chernov, Lukas Schmid and Dongho Song

No 27231, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We quantify the impact of risk-based and non-risk-based intermediary constraints (IC) on the term structure of CIP violations. Using a stochastic discount factor (SDF) inferred from interest rate swaps, we value currency derivatives. The wedge between model-implied and observed derivative prices reflects the impact of non-risk-based IC because our SDF incorporates risk-based IC. There is no wedge at short horizons, while the wedge accounts for 40% of long-term CIP violations. Consistent with IC theory, the wedge correlates with the shadow cost of intermediary capital, and the SDF-implied interest rate is a weighted average of collateralized and uncollateralized interest rates.

JEL-codes: C01 E43 E44 G12 H60 (search for similar items in EconPapers)
Date: 2020-05
New Economics Papers: this item is included in nep-mac
Note: AP IFM
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Published as PATRICK AUGUSTIN & MIKHAIL CHERNOV & LUKAS SCHMID & DONGHO SONG, 2024. "The Term Structure of Covered Interest Rate Parity Violations," The Journal of Finance, vol 79(3), pages 2077-2114.

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Journal Article: The Term Structure of Covered Interest Rate Parity Violations (2024)
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