Fed in Print

Board of Governors of the Federal Reserve System (U.S.)

International Finance Discussion Papers

Abstract

This paper examines the connection between deviations in covered interest rate parity and differences in the credit spread of bonds of similar risk but different currency denomination. These two pricing anomalies are highly aligned in both the time series and the cross-section of currencies. The composite of these two pricing deviations – the corporate basis – represents the currency-hedged borrowing cost difference between currency regions and explains up to a third of the variation in the aggregate corporate debt issuance flow. I show that arbitrage aimed at exploiting one type of security anomaly can give rise to the other.

Gordon Y. Liao, Credit Migration and Covered Interest Rate Parity, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1255, Aug 2019.

JEL Classification:

E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
F3 - International Economics - - International Finance
F55 - International Economics - - International Relations, National Security, and International Political Economy - - - International Institutional Arrangements
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

Keywords: Covered interest rate parity ; Limits of arbitrage ; Credit market segmentation ; Debt issuance ; Dollar convenience yield ; Foreign exchange rate hedge

This item with handle RePEc:fip:fedgif:1255 is also listed on EconPapers and IDEAS.

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