Monetary policy and covered interest parity in the post GFC period: Evidence from the Australian dollar and the NZ dollar |
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| Institution: | 1. Faculty of Economics, University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo 113-0033, Japan;2. Faculty of Economics, Musashino University, 3-3-3 Ariake, Koto-ku, Tokyo 135-8181, Japan;1. Department of Finance and Economics, Georgia Southern University, 1332 Southern Drive, Statesboro, GA 30458, USA;2. The John B. and Lillian E. Neff Endowed Chair in Finance, The University of Toledo, 2801 W. Bancroft Street, Toledo, OH 43606, USA;1. Department of Economics, Chinese University of Hong Kong, Shatin, N.T., Hong Kong;2. Research Development Center, GF Securities Co., Ltd., 16/F, Shanghai IFC Building, Pudong, Shanghai, PR China;3. School of Management and Economics, CUHK Business School, Chinese University of Hong Kong (Shenzhen), 2001 Longxiang Boulevard, Longgang District, Shenzhen, Guangdong Province, PR China;1. School of Mathematics and Statistics, The University of Sydney, and Center for Applied Financial Studies, University of South Australia, Australia;2. Department of Quantitative Finance, College of Technology Management, National Tsing Hua University, Taiwan;3. Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam, The Netherlands;4. School of Business and Law, Edith Cowan University, Australia;5. Distinguished Visiting Professor, Department of Quantitative Economics, Complutense University of Madrid, Spain;6. Adjunct Professor, Department of Mathematics and Statistics, University of Canterbury Christchurch, New Zealand;7. IAS Adjunct Professor, Institute of Advanced Sciences, Yokohama National University, Japan |
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| Abstract: | After the global financial crisis (GFC), most major currencies had higher interest rates than the US dollar on forward contract because of increased demand for the US dollar as international liquidity. However, unlike the other major currencies, the Australian dollar and the NZ dollar had lower interest rates than the US dollar on forward contract in the post GFC period. The purpose of this paper is to explore why this happened through estimating the covered interest parity (CIP) condition. In the analysis, we focus on a unique feature of Australia and New Zealand where short-term interest rates remained significantly positive even after the GFC. The paper first constructs a theoretical model where increased liquidity risk causes deviations from the CIP condition. It then tests this theoretical implication by using daily data of six major currencies. We find that both money market risk measures and policy rates had significant effects on the CIP deviations. The result implies that unique monetary policy feature in Australia and New Zealand made deviations from the CIP condition distinct on the forward contract. |
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| Keywords: | Covered interest parity Monetary policy The global financial crisis |
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