Covered Interest Rate Parity Deviations In External Emerging Market Sovereign Debt
Journal of Fixed Income, Vol. 29, No. 4, 2020, https://jfi.pm-research.com/content/29/4/92
Posted: 12 Sep 2019
Date Written: September 1, 2019
Abstract
Non-U.S. dollar denominated external emerging market debt issuance in euros, yen, and sterling has grown substantially in recent years. This paper is the first study to explore how non-dollar external emerging market bonds violate covered interest rate parity relative to their dollar-denominated external emerging market debt counterpart bonds for a given country. Such mispricing in the post-Great Recession era creates arbitrage opportunities for investors and suggests that emerging market country policymakers could create fiscal savings by instead more cheaply issuing external sovereign debt in dollars (versus non-dollar developed world currencies like euro, yen, and sterling) and swapping the proceeds to non-dollar currencies with currency forward and spot transactions. Such hypothetical fiscal savings from switching to dollar funding collectively are estimated to be more than $1 billion annually.
Keywords: Behavioral Finance, Exchange Rates, Fixed Income, Arbitrage, Dollar Funding, Government Debt Management
JEL Classification: E43, F31, G15, G28, G40, H63
Suggested Citation: Suggested Citation