A rank approach for studying cross-currency bases and the covered interest rate parity

Ordoñez-Callamand, Daniel; Gómez-González, José Eduardo; Gomez-Malagon, Santiago; Melo-Velandia, Luis Fernando

A rank approach for studying cross-currency bases and the covered interest rate parity

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Borradores de Economía; No. 994

Date published

2017-05-08

Date

2017-05-08

Authors

Ordoñez-Callamand, Daniel
Gómez-González, José Eduardo
Gomez-Malagon, Santiago
Melo-Velandia, Luis Fernando

Document language

eng

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Las opiniones contenidas en el presente documento son responsabilidad exclusiva de los autores y no comprometen al Banco de la República ni a su Junta Directiva.

The opinions contained in this document are the sole responsibility of the author and do not commit Banco de la República or its Board of Directors.

Abstract

We use the recently developed panel rank-cointegration test proposed by Pedroni et al. [2015] to check for the stability conditions of the cross-country money market interest rate bases. Using weekly information on short-term interest rates and spot and forward exchange rates for a set of 20 European economies during 2005-2017, we show that in most cases these bases are non-stationary, implying the failure of the Covered Interest Rate Parity condition. Concretely, a mean-reverting behavior is encountered in only two cases. The first includes Greece, Italy and Portugal, while the second Belgium, France and Germany.

JEL Codes

C12 - Hypothesis Testing: General
C33 - Multiple/Simultaneous Equation Models; Multiple Variables: Panel Data Models; Spatio-temporal Models
E43 - Interest Rates: Determination, Term Structure, and Effects

Keywords

Paridad cubierta de tasas de interés , Pruebas de rango no paramétricas , Cointegración , Series de tiempo en panel , Tipos de cambio cruzado

Keywords

Covered interest rate parity , Nonparametric rank tests , Cointegration , Time series

Citation

N. Baba and F. Packer. Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08. Journal of Banking & Finance, 33(11):1953 – 1962, 2009.
C. F. Baum and J. Barkoulas. Dynamics of intra-ems interest rate linkages. Journal of Money, Credit, and Banking, 38(2):469–482, 2006.
C. Borio, R. McCauley, P. McGuire, and V. Sushko. Covered interest parity lost: understanding the cross-currency basis. Working paper, Bank of International Settlements, September 2016.