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  5. Arbitraging Covered Interest-Rate Parity Deviations and Bank Lending

Arbitraging Covered Interest-Rate Parity Deviations and Bank Lending

  • Lorena Keller
American Economic Review (Forthcoming)

Abstract

I propose and test a new channel through which covered interestrate parity (CIP) deviations can affect bank lending in emerging economies. I argue that when CIP deviations exist, banks attempt to arbitrage them. To do so, banks must borrow in a particular currency. When this currency is scarce, bank lending in the currency required to arbitrage decreases, while they use this currency in their arbitrage activities. I test this channel by exploiting differences in the abilities of Peruvian banks to arbitrage CIP deviations. I find evidence that supports the proposed channel.

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