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.

Abstract

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Cross-currency bases; covered interest rate parity; bank regulation; liquidity
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets; O - Economic Development, Innovation, Technological Change, and Growth > O2 - Development Planning and Policy > O24 - Trade Policy ; Factor Movement Policy ; Foreign Exchange Policy

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