Munich Personal RePEc Archive

CIP deviations: The role of U.S. banks’ liquidity and regulations

Bazán, Walter and Ortiz, Marco and Terrones, Marco and Winkelried, Diego (2023): CIP deviations: The role of U.S. banks’ liquidity and regulations.

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This paper inquires how private bank regulation and liquidity in the US are related to the deviations from the covered interest parity (CIP) condition. We find evidence that bank liquidity effects on CIP deviations partially offset those resulting from regulatory changes in a sample of 11 OECD countries over the 2001-2019 period. This finding supports an old conjecture that changes in private banks' liquidity and regulation could significantly affect the wedge between liquid US dollars and illiquid foreign exchange forward contracts in international financial markets. Interestingly, the effects of liquidity on CIP deviations become more important when the impact of bank regulation intensifies, reflecting the presence of interaction effects.

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