Credit migration and covered interest rate parity

This paper examines the joint determination of deviations in long-term 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 curre...

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Bibliographic Details
Published in:Journal of financial economics Vol. 138; no. 2; pp. 504 - 525
Main Author: Liao, Gordon Y.
Format: Journal Article
Language:English
Published: Amsterdam Elsevier B.V 01.11.2020
Elsevier Sequoia S.A
Subjects:
Arbitrage
Bonds
Corporate debt
Covered interest rate parity
Credit
Credit spread
Currency
Debt
Debt financing (Corporations)
Debt issuance
Federal Reserve banks
Financial economics
Foreign exchange
Foreign exchange rate hedging
Hedging (Finance)
Interest rate parity theorem
Interest rates
Limits of arbitrage
Migration
Monetary policy
Prices and rates
Time series
Debt issuance
E44
F55
G32
G12
G23
G15
G28
F3
Foreign exchange rate hedging
Credit spread
Limits of arbitrage
Covered interest rate parity
ISSN:0304-405X, 1879-2774
Online Access:Get full text
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Summary:This paper examines the joint determination of deviations in long-term 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 sum 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.
Bibliography:ObjectType-Article-1
SourceType-Scholarly Journals-1
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ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2020.06.002