Empirical Explanation of Covered Interest Parity Deviations During Financial Crises

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Abstract/Contents

Abstract: My paper aims to analyze the 2008 financial crisis, when Covered Interest Parity (CIP) between the U.S. dollar and the euro appears to have deviated by hundreds of basis points to historically unprecedented levels. In existing literature, this deviation is attributed to heightened credit risk spreads and dollar liquidity premiums. However, my paper shows that the Term Fed Funds explain the majority of these observed market deviations. I thus argue that covered interest parity did not fail as an economic model, but rather that panel banks underreported their true borrowing rates in the London Inter-Bank Offered Rate (LIBOR) survey. Ultimately I conclude that LIBOR, which is linked to more than $90 trillion of financial derivatives, broke down as an accurate measure of true interest rates during the 2008 financial crisis.

Type of resource	text
Date created	May 2010

Author	Vacek, Tomas
Primary advisor	Taylor, John B.
Degree granting institution	Stanford University, Department of Economics

Subject	Stanford Department of Economics
Subject	Covered Interest Parity
Subject	LIBOR
Subject	Term Fed Funds
Subject	Cross Currency Basis
Genre	Thesis

Related item	Title 2010 Anna Laura Myers Prize for an Outstanding Thesis
Location	https://purl.stanford.edu/qf930rw4572

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Preferred Citation: Vacek, Tomas. (2010). Empirical Explanation of Covered Interest Parity Deviations During Financial Crises. Stanford Digital Repository. Available at: https://purl.stanford.edu/qf930rw4572

Stanford University, Department of Economics, Honors Theses

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