Trading and arbitrage in cryptocurrency markets

We find that deviations from the covered interest rate parity (CIP) condition imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world. Contrary to the common view, these deviations for major currencies are not explained away by credit risk or transaction costs. They are particularly strong for forward contracts that appear on banks' balance sheets at the end of the quarter, pointing to a causal effect of banking regulation on asset prices. The CIP deviations also appear significantly correlated with other fixed income spreads and with nominal interest rates.

/pdf/deviations-from-covered-interest-rate-parity-3hlghovxtx.pdf

Deviations from Covered Interest Rate Parity

We find that deviations from the covered interest rate parity condition (CIP) imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world Contrary to the common view, these deviations for major currencies are not explained away by credit risk or transaction costs They are particularly strong for forward contracts that appear on the banks' balance sheets at the end of the quarter, pointing to a causal effect of banking regulation on asset prices The CIP deviations also appear significantly correlated with other fixed-income spreads and with nominal interest rates

Currency unions and trade: A post-EMU reassessment

The failure of covered interest parity (CIP), or, equivalently, the persistence of the cross currency basis, in tranquil markets has presented a puzzle Focusing on the basis against the US dollar (USD), we show that the CIP deviations that are not due to transaction costs or bank credit risk can be explained by the demand to hedge USD forward Fluctuations in FX hedging demand matter because committing the balance sheet to arbitrage is costly With limits to arbitrage, CIP arbitrageurs charge a premium in the forward markets for taking the other side of FX hedgers' demand We find that measures of FX hedging demand, combined with proxies for the risks associated with CIP arbitrage, improve the explanatory power of standard regressions

/pdf/the-failure-of-covered-interest-parity-fx-hedging-demand-and-3q3j3xoyw4.pdf

The failure of covered interest parity: FX hedging demand and costly balance sheets

This paper studies the violation of the most basic no-arbitrage condition in international finance - Covered Interest Parity (CIP). To understand the CIP conundrum, it is key to (i) account for funding frictions in U.S. dollar money markets, and (ii) to study the challenges of swap intermediaries when funding liquidity evolves differently across major currency areas. We find that CIP holds remarkably well for most potential arbitrageurs when applying their marginal funding rates. With severe funding liquidity differences, however, it becomes impossible for dealers to quote prices such that CIP holds across the full rate spectrum. A narrow set of global top-tier banks enjoys risk-less arbitrage opportunities as dealers set quotes to avert order flow imbalances. We show how a situation with persistent arbitrage profits arises as an equilibrium outcome due to the constellation of market segmentation, the abundance of excess reserves and their remuneration in central banks' deposit facilities.

/pdf/segmented-money-markets-and-covered-interest-parity-4v0942xi2x.pdf

Segmented money markets and covered interest parity arbitrage

We show that it is crucial to account for the heterogeneity in funding costs, both across banks and across currency areas, in order to understand recently documented deviations from Covered Interest Parity (CIP). When CIP arbitrage is implemented accounting for marginal funding costs and realistic risk-free investment instruments, the no-arbitrage relation holds fairly well for the majority of market participants. A narrow set of global high-rated banks, however, does enjoy riskless arbitrage opportunities. Such arbitrage opportunities emerge as an equilibrium outcome as FX swap dealers set prices to avoid inventory imbalances. Low-rated banks find it attractive to turn to the FX swap market to cover their U.S. dollar funding, while swap dealers elicit opposite (arbitrage) flows by high-rated banks. Such arbitrage opportunities are difficult to scale, with funding rates adjusting as soon as arbitrageurs increase their positions.

Covered Interest Parity Arbitrage

We examine the alternative reference rates that are set to replace the London Interbank Offered Rate (LIBOR) as benchmark rate by the end of 2021. After providing the relevant background, we show that: (i) depending on the marginal lenders, tighter regulatory constraints can either increase or decrease the alternative benchmarks; (ii) increases in the amount of government debt outstanding increase the alternative benchmarks, more so for collateralized rates; (iii) more central bank reserves lower the alternative benchmarks. In addition, we show that term rates based on the alternative reference rates can be detached from banks' marginal funding costs.

Life After LIBOR

Life after LIBOR

This article guides through the measures implemented in Norway in order to dampen negative effects stemming from the financial crisis. We also discuss some features of the Norwegian money market and the liquidity system in Norway. From the point of view of central banks, the widening gap between money market rates and the key policy rate has been one disturbing element of the financial crises. We develop a simple model, which illustrates how developments in forward exchange premiums can provide insight as to why money market premiums differ across currencies. The model shows that the excess supply of term liquidity in dollar relative to the excess supply of term liquidity in other currencies has an impact on the domestic money market premium relative to that on USD.

Olav Syrstad

Papers

Segmented money markets and covered interest parity arbitrage

Covered Interest Parity Arbitrage

Life After LIBOR

Life after LIBOR

The financial crisis in Norway: effects on financial markets and measures taken