The Term Structure of Covered Interest Rate Parity Violations

53 Pages Posted: 26 May 2020 Last revised: 29 May 2022

See all articles by Patrick Augustin

Patrick Augustin

McGill University; McGill University, Desautels Faculty of Management

Mikhail Chernov

UCLA Anderson

Lukas Schmid

University of Southern California - Marshall School of Business

Dongho Song

Johns Hopkins University - Carey Business School

Multiple version iconThere are 2 versions of this paper

Date Written: May 2020

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.

Suggested Citation

Augustin, Patrick and Augustin, Patrick and Chernov, Mikhail and Schmid, Lukas and Song, Dongho, The Term Structure of Covered Interest Rate Parity Violations (May 2020). NBER Working Paper No. w27231, Available at SSRN: https://ssrn.com/abstract=3609684

Patrick Augustin (Contact Author)

McGill University ( email )

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McGill University, Desautels Faculty of Management ( email )

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HOME PAGE: http://www.patrickaugustin.se

Mikhail Chernov

UCLA Anderson ( email )

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Lukas Schmid

University of Southern California - Marshall School of Business ( email )

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Los Angeles, CA California 90089
United States

Dongho Song

Johns Hopkins University - Carey Business School ( email )

Baltimore, MD 20036-1984
United States

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