Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the...

90
CIP deviations during the crisis Covered interest rate parity deviations during the crisis Tommaso Mancini Griffoli, Angelo Ranaldo SNB research unit BOP - SNB Joint Conference, Zurich June 15, 2009 1

Transcript of Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the...

Page 1: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Covered interest rate parity deviations during the crisis

Tommaso Mancini Griffoli, Angelo RanaldoSNB research unit

BOP - SNB Joint Conference, Zurich June 15, 2009

1

Page 2: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

2

Page 3: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

2

Page 4: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Covered Interest Parity (CIP)

3

i* i

Page 5: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Covered Interest Parity (CIP)

3

i* i

depreciation

Page 6: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Covered Interest Parity (CIP)

3

i* i

depreciation

=

Page 7: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

Note: S is domestic per foreign currency units.

Page 8: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

1S

Note: S is domestic per foreign currency units.

Page 9: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

(1+i*)1S

Note: S is domestic per foreign currency units.

Page 10: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

(1+i*)SF

Note: S is domestic per foreign currency units.

Page 11: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

(1+i*) (1+i)=SF

Note: S is domestic per foreign currency units.

Page 12: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

(1+i*) (1+i)=SF

interest differential

Note: S is domestic per foreign currency units.

Page 13: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

4

(1+i*) (1+i)=SF

interest differentialdepreciation(forward premium)

Note: S is domestic per foreign currency units.

Page 14: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP balancing

5

(1+i*) (1+i)>SF

Note: S is domestic per foreign currency units.

Page 15: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP balancing

5

(1+i*) (1+i)>SF

• Riskless gains!• Sell (short) domestic currency spot• Buy (long) domestic currency forward

Note: S is domestic per foreign currency units.

Page 16: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP balancing

5

(1+i*) (1+i)>SF

• Riskless gains!• Sell (short) domestic currency spot• Buy (long) domestic currency forward

Note: S is domestic per foreign currency units.

Page 17: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP balancing

5

(1+i*) (1+i)SF

• Riskless gains!• Sell (short) domestic currency spot• Buy (long) domestic currency forward

=

Note: S is domestic per foreign currency units.

Page 18: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

In theory...

• CIP should always hold!

• Otherwise, infinite Sharpe ratios!

6

Page 19: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

In practice...

• Some deviations in CIP

‣ Over short periods (Taylor ’89)

‣ Over longer periods... since Lehman

- Baba, Packer & Nagano (BIS ’08), Baba & Packer (BIS ’09), Coffey, Hrung, Nguyen & Sarkar (NYFed ’09), others...

7

Page 20: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP deviations

8

Returns, long EURCHF, Libor no tc (%)

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

12/4

/06

2/4/

07

4/4/

07

6/4/

07

8/4/

07

10/4

/07

12/4

/07

2/4/

08

4/4/

08

6/4/

08

8/4/

08

10/4

/08

12/4

/08

2/4/

09

4/4/

09

Page 21: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

The story is more complicated!

9

Page 22: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

10

Page 23: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Problems with using Libor• Ask

• Indicative

• Not representative

• Strategic

• Poor timing

• May not have been used by speculators!

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Page 24: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

A more realistic rate...another funding market

• Bid-Ask spreads

• Traded/ firm prices

• Continuous quotes

• Avoid counterparty risk

• Avoid low liquidity

12

Page 25: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

A more realistic rate...another funding market

• Bid-Ask spreads

• Traded/ firm prices

• Continuous quotes

• Avoid counterparty risk

• Avoid low liquidity

12

Page 26: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Overnight rates

Bid-Ask spreads

Traded/ firm prices

Continuous quotes

Avoid counterparty risk

Avoid low liquidity

13

Page 27: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Overnight rates

Bid-Ask spreads

Traded/ firm prices

Continuous quotes

Avoid counterparty risk

Avoid low liquidity

13

√

Page 28: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Overnight rates

Bid-Ask spreads

Traded/ firm prices

Continuous quotes

Avoid counterparty risk

Avoid low liquidity

13

√√

Page 29: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Overnight rates

Bid-Ask spreads

Traded/ firm prices

Continuous quotes

Avoid counterparty risk

Avoid low liquidity

13

√√√

Page 30: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Overnight rates

Bid-Ask spreads

Traded/ firm prices

Continuous quotes

Avoid counterparty risk

Avoid low liquidity

13

√√√√

Page 31: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Overnight rates

Bid-Ask spreads

Traded/ firm prices

Continuous quotes

Avoid counterparty risk

Avoid low liquidity

13

√√√√√

Page 32: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

Page 33: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

Long i

Short j

SPOT

Page 34: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

Long i

Short j

SPOT

pay O/N j

get O/N i

FUNDING

Page 35: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

get O/N i

get O/N i

get O/N i

pay O/N j

pay O/N j

pay O/N j

Long i

Short j

SPOT

pay O/N j

get O/N i

FUNDING

Page 36: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

get O/N i

get O/N i

get O/N i

pay O/N j

pay O/N j

pay O/N j Long j

Short i

FORWARD

Long i

Short j

SPOT

pay O/N j

get O/N i

FUNDING

Page 37: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

get O/N i

get O/N i

get O/N i

pay O/N j

pay O/N j

pay O/N j Long j

Short i

FORWARD

Long i

Short j

SPOT

pay O/N j

get O/N i

FUNDING

OIS j

Page 38: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

get O/N i

get O/N i

get O/N i

pay O/N j

pay O/N j

pay O/N j Long j

Short i

FORWARD

Long i

Short j

SPOT

pay O/N j

get O/N i

FUNDING

OIS j

OIS i

Page 39: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Arbitrage mechanics

14

get O/N i

get O/N i

get O/N i

pay O/N j

pay O/N j

pay O/N j Long j

Short i

FORWARD

Long i

Short j

SPOT

pay O/N j

get O/N i

FUNDING

OIS j

OIS i

(bid j)

(ask i) (bid i)

(ask j)

Page 40: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP balancing

15

(1+i*) (1+i)=SF

Note: S is domestic per foreign currency units.

Page 41: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP balancing

15

(1+i*) (1+i)=SF

Note: S is domestic per foreign currency units.

Page 42: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP condition

16

(1+OIS*B) (1+OISA)=SA

FB

Note: S is domestic per foreign currency units, conventionally referred to as foreign-domestic exchange rate. Buying foreign currency spot is equivalent to emitting a bid for the foreign-domesic rate, thus buying at the market’s ask price, as in SA in the denominator.

Page 43: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CIP profits

17

(1+OIS*B) (1+OISA)_SA

FB

Note: S is domestic per foreign currency units, conventionally referred to as foreign-domestic exchange rate. Buying foreign currency spot is equivalent to emitting a bid for the foreign-domesic rate, thus buying at the market’s ask price, as in SA in the denominator.

Page 44: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

18

Page 45: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Libor (no transaction costs)

19

Returns, long EURCHF, Libor no tc (%)

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

12/4

/06

2/4/

07

4/4/

07

6/4/

07

8/4/

07

10/4

/07

12/4

/07

2/4/

08

4/4/

08

6/4/

08

8/4/

08

10/4

/08

12/4

/08

2/4/

09

4/4/

09

Page 46: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

OIS (no trans costs)

20

Returns… + OIS no tc (%)

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

12/4

/06

2/4/

07

4/4/

07

6/4/

07

8/4/

07

10/4

/07

12/4

/07

2/4/

08

4/4/

08

6/4/

08

8/4/

08

10/4

/08

12/4

/08

2/4/

09

4/4/

09

Ret long LiborEur w/t tcRet long OISEur no tc

Page 47: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

OIS (with trans costs)

21

Returns… + OIS with tc (%)

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

12/4

/06

2/4/

07

4/4/

07

6/4/

07

8/4/

07

10/4

/07

12/4

/07

2/4/

08

4/4/

08

6/4/

08

8/4/

08

10/4

/08

12/4

/08

2/4/

09

4/4/

09

Ret long LiborEur w/t tc

Ret long OISEur no tc

Ret long OISEur w/ tc, w/t fxtc

Page 48: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

FX (with trans costs)

22

Returns… + FX with tc (%)

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

12/4

/06

2/4/

07

4/4/

07

6/4/

07

8/4/

07

10/4

/07

12/4

/07

2/4/

08

4/4/

08

6/4/

08

8/4/

08

10/4

/08

12/4

/08

2/4/

09

4/4/

09

Ret long LiborEur w/t tcRet long OISEur no tcRet long OISEur w/ tc, w/t fxtcRet long Eur

Page 49: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

23

Page 50: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Libor OIS

• Profits change... get rid of default risk

‣ if Libor-OIS spreads higher in target currency

- profits decrease

‣ if Libor-OIS spreads higher in funding currency

- profits increase

24

Page 51: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Libor OIS

25

= α + β (Libor-OIS related variable) + ...CIP profits(Libor, no tc)

Page 52: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Libor OIS

• β will turn out significant

• Tell stories about national vs. foreign default risk

• But uninformative!

25

= α + β (Libor-OIS related variable) + ...CIP profits(Libor, no tc)

Page 53: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Other remarks

• OIS transaction costs hardly affect profits

• FX transaction costs make a significant difference

• Similar results for other currency pairs

26

Page 54: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Main message

• Using more detailed and realistic measures:

‣ Fewer, lower & less persistent CIP deviations

‣ But deviations remain!

‣ Despite our “stricter” test

27

Page 55: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Main message

• Using more detailed and realistic measures:

‣ Fewer, lower & less persistent CIP deviations

‣ But deviations remain!

‣ Despite our “stricter” test

27

We must look further... perhaps at currencies themselves

Page 56: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

28

Page 57: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Long USD positions

29

Returns, short EURUSD (%)

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1

1/1/

001/

25/0

02/

18/0

03/

13/0

04/

6/00

4/30

/00

5/24

/00

6/17

/00

7/11

/00

8/4/

008/

28/0

09/

21/0

010

/15/

0011

/8/0

012

/2/0

012

/26/

001/

19/0

12/

12/0

13/

8/01

4/1/

014/

25/0

15/

19/0

16/

12/0

17/

6/01

7/30

/01

8/23

/01

9/16

/01

10/1

0/01

11/3

/01

11/2

7/01

12/2

1/01

1/14

/02

2/7/

023/

3/02

3/27

/02

Page 58: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Short USD positions

30

Returns, long EURUSD (%)

-0.1

0

0.1

0.2

0.3

0.4

0.5

1/1/

001/

25/0

02/

18/0

03/

13/0

04/

6/00

4/30

/00

5/24

/00

6/17

/00

7/11

/00

8/4/

008/

28/0

09/

21/0

010

/15/

0011

/8/0

012

/2/0

012

/26/

001/

19/0

12/

12/0

13/

8/01

4/1/

014/

25/0

15/

19/0

16/

12/0

17/

6/01

7/30

/01

8/23

/01

9/16

/01

10/1

0/01

11/3

/01

11/2

7/01

12/2

1/01

1/14

/02

2/7/

023/

3/02

3/27

/02

Page 59: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Further clues• Very similar charts for other currency pairs

‣ long dollar (–) profits

‣ short dollar (+) profits

• CIP deviations seem to be

‣ currency specific (dollar)

‣ directional (short dollar)

31

Page 60: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Agenda• CIP basics and motivation

• CIP details

• CIP initial empirics

• Some takeaways

• More empirics

• A theory of CIP breakdown

32

Page 61: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Short USD profitable

33

(1+OISEUR) (1+OISUSD)>SA

FB

Page 62: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Short USD profitable

33

(1+OISEUR) (1+OISUSD)>SA

FB

Page 63: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Short USD profitable

33

(1+OISEUR) (1+OISUSD)>SA

FB

Page 64: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Short USD profitable

33

(1+OISEUR) (1+OISUSD)>SA

FB

Page 65: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Short USD profitable

33

(1+OISEUR) (1+OISUSD)>SA

FB

• FB too high• USD too cheap on FWD market

Page 66: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Towards a theory• FWD not priced according to CIP

• Usually, price pressure on FWD comes from arbitrageurs,

• Who short an appreciating currency (for given OIS differential)

• But if - for some reason - arbitrage is insufficient, FWD becomes “stale” (as seen from CIP)

• Thus, spot movements determine if CIP profits are positive or negative

34

Page 67: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Page 68: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

EURUSD

t

Page 69: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Investors

Speculators

EURUSD

t

Page 70: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Investors

Speculators

EURUSD

t

spot

Page 71: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Investors

Speculators

EURUSD

t

spot

forward

Page 72: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Investors

Speculators

EURUSD

t

spot

forwardCIP i-rate diff

Page 73: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Investors

Speculators

EURUSD

t

spot

forwardCIP i-rate diff

forwardCIP i-rate diff

“excess” USD depreciation; CIP breakdown

forward

Page 74: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

An illustration

35

Investors

Speculators

EURUSD

t

spot

forwardCIP i-rate diff

forwardCIP i-rate diff

“excess” USD depreciation; CIP breakdown

forward

Page 75: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

The short USD experience• Enormous pressure to obtain USD spot USD

appreciation

• Speculators should have shorted USD

• But... insufficient USD available to borrow

• Thus insufficient pressure on USD forward

• Resulting in “excess” USD future depreciation inducing positive CIP profits

36

Page 76: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

The short USD experience• Enormous pressure to obtain USD spot USD

appreciation

• Speculators should have shorted USD

• But... insufficient USD available to borrow

• Thus insufficient pressure on USD forward

• Resulting in “excess” USD future depreciation inducing positive CIP profits

36

• No notion of risk!• A funding liquidity constraint!

Page 77: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Long USD unprofitable, same story from flip side

• Positive profits with short USD position

• Negative profits with long USD position

• Except if bid-ask spreads are particularly high relative to profits

37

Page 78: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Regressions support our story

38

Long USD Short USDBAS fwdBAS spot

Balance sheetTED

VIX/ CDS

Page 79: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Regressions support our story

38

Long USD Short USDBAS fwdBAS spot

Balance sheetTED

VIX/ CDS

BAS FWD

BAS spot

Balance sheet

TED

Funding liquidity

constraint

Page 80: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Regressions support our story

38

Long USD Short USDBAS fwdBAS spot

Balance sheetTED

VIX/ CDS

BAS FWD

BAS spot

Balance sheet

TED

Funding liquidity

constraint

VIX/ CDSRisk

Page 81: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Regressions support our story

38

Long USD Short USDBAS fwdBAS spot

Balance sheetTED

VIX/ CDS

BAS FWD

BAS spot

Balance sheet

TED

Funding liquidity

constraint

VIX/ CDSRisk

– ++ –+ –– +no no

Page 82: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

– – 5.7 ***+ 4.9 ***+ 4.4 ***– – 1.7 ***no not signft

Regressions support our story

39

Long USDBAS fwdBAS spot

Balance sheetTED

VIX/ CDS

Page 83: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

– – 5.7 ***+ 4.9 ***+ 4.4 ***– – 1.7 ***no not signft

Regressions support our story

39

Long USDBAS fwdBAS spot

Balance sheetTED

VIX/ CDS

√√√√√

Page 84: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Summary• CIP deviations, can you believe it?

• CIP arbitrage is complex,

• Literature is too superficial

• Our measure excludes default risk and includes transaction costs (& other benefits)

• But still, deviations exist, although smaller, less frequent and persistent

40

Page 85: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Summary• Study across various currency pairs reveals

‣ short USD positions profitable

• A theory: funding liquidity constraints limit arbitrage

‣ forward price is stale and spot deviations determine CIP arbitrage profitability

• Supported by evidence & regression analysis

41

Page 86: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Summary

• More perspective:

‣ find limits to theoretical zero-risk arbitrage conditions at heart of finance,

‣ more concretely, find which currencies were in excessive demand due to technical reasons during the crisis... USD and CHF

42

Page 87: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

Appendix

43

Page 88: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CHF story similar to above

• Great pressure to obtain CHF

• Spot CHF appreciation but limited short CHF speculation (funding liquidity constraint),

• Leaving CHF “too cheap” on fwd market,

• Thus offering profitable short CHF arbitrage

44

Page 89: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

CHF story similar to above

• ... as seen in Libor CIP measure,

• but not with our measure due to significant increase in transaction costs

45

Returns… + FX with tc (%)

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

12/4

/06

2/4/

07

4/4/

07

6/4/

07

8/4/

07

10/4

/07

12/4

/07

2/4/

08

4/4/

08

6/4/

08

8/4/

08

10/4

/08

12/4

/08

2/4/

09

4/4/

09

Ret long LiborEur w/t tcRet long Eur

Page 90: Presenation: Covered interest rate parity deviations during the crisis · CIP deviations during the crisis CIP condition 16 (1+OIS*B) = (1+OISA) SA FB Note: S is domestic per foreign

CIP deviations during the crisis

USDEUR, Libor and Net

46

Returns, long EURUSD (%)

-0.1

0

0.1

0.2

0.3

0.4

0.5

3/1/

06

5/1/

06

7/1/

06

9/1/

06

11/1

/06

1/1/

07

3/1/

07

5/1/

07

7/1/

07

9/1/

07

11/1

/07

1/1/

08

3/1/

08

5/1/

08

7/1/

08

9/1/

08

11/1

/08

1/1/

09

3/1/

09

Libor, no trans costs

OIS & FX with transcosts


Pilot Deviations

Pilot Deviations

Sexual deviations short

Sexual deviations short

Reducing Pilot Deviations

Reducing Pilot Deviations

Launch Condition Deviations of Reusable Launch … Condition Deviations of Reusable Launch Vehicle Simulations in ... Launch Condition Deviations of Reusable ... condition from the

Launch Condition Deviations of Reusable Launch … Condition Deviations of Reusable Launch Vehicle Simulations in ... Launch Condition Deviations of Reusable ... condition from the

CIP Overview 1. Purposes of the CIP What Does CIP Success Look Like? Identifying the Team Roles of LEA, Principal, and CIP Team CIP Timeline 2.

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Altitude Deviations

Altitude Deviations

C OIC H C OiSa { (fr.EOJ o EoJrE j-o-E €EEiE ;f:; f;{ E= 3-E ......@-C C OIC H C OiSa{ (fr.EOJ @ @ C € -r @ C\OCLO >,O. CnOC,\CLt-

C OIC H C OiSa { (fr.EOJ o EoJrE j-o-E €EEiE ;f:; f;{ E= 3-E ......@-C C OIC H C OiSa{ (fr.EOJ @ @ C € -r @ C\OCLO >,O. CnOC,\CLt-

Route Deviations

Route Deviations

Deviations from Covered Interest Rate Parity...We nd that deviations from the covered interest rate parity condition (CIP) imply large, persistent, and systematic arbitrage opportunities

Deviations from Covered Interest Rate Parity...We nd that deviations from the covered interest rate parity condition (CIP) imply large, persistent, and systematic arbitrage opportunities

Deviations from Covered Interest Rate Parity - … · Deviations from Covered Interest Rate Parity Wenxin Du y ... the International Monetary Fund, ... The intuition for the CIP condition

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Noncompliance: Deviations, Solutions and Corrective Actions JERI BARNEY, JD, MS, CIP, SENIOR COMPLIANCE MANAGER JESS RANDALL, MA, CIP, COMPLIANCE MANAGER.

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UNANTICIPATED PROBLEMS INVOLVING RISKS TO SUBJECTS OR OTHERS & INCIDENTS OF NON-COMPLIANCE ( AKA PROTOCOL DEVIATIONS ) TRACY RIGHTMER, JD, CIP COMPLIANCE.

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CIP v5 Advanced Workshop From CIP-‐002-‐3 to CIP-‐002-‐5.1: A ...

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Unconventional Monetary Policy and Covered Interest Rate Parity Deviations… · Covered interest rate parity (CIP) ... swaps are among the most widely traded derivative instruments,

Unconventional Monetary Policy and Covered Interest Rate Parity Deviations… · Covered interest rate parity (CIP) ... swaps are among the most widely traded derivative instruments,

Lessons Learned from Commission-Led CIP Reliability Audits · 2020. 5. 12. · CIP-004-3, CIP-005-3, CIP-006-3, CIP-007-3, CIP-008-3, and CIP-009-3. 13. The NERC Glossary defines

Lessons Learned from Commission-Led CIP Reliability Audits · 2020. 5. 12. · CIP-004-3, CIP-005-3, CIP-006-3, CIP-007-3, CIP-008-3, and CIP-009-3. 13. The NERC Glossary defines

CIP-003-7 & CIP-003-8 Effective Dates and... · CIP-003-8 R4 Delegate CIP Senior Manager authority 7/1/2016 9. CIP Reliability Standard Effective Date CIP-005-6 July 1, 2020 CIP-008-6

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LARGE DEVIATIONS - USTC

LARGE DEVIATIONS - USTC

ocular Deviations

ocular Deviations

Deviations from covered interest rate parity and capital ...€¦ · The covered interest rate parity (CIP) condition, almost considered a physical law in international finance, states

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Transfemoral Gait Deviations

Transfemoral Gait Deviations