{
  "title": "Uncovering CIP Deviations in Emerging Markets: Distinctions, Determinants and Disconnect",
  "publication": "IMF Working Papers, February 10, 2023",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2023/02/10/uncovering-cip-deviations-in-emerging-markets-distinctions-determinants-and-disconnect-529681",
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  "summary": "We provide a systematic empirical treatment of short-term Covered Interest Parity (CIP) deviations for a large set of emerging market (EM) currencies. EM CIP deviations have much larger volatilities than most G10 currencies and move in an opposite direction during global risk-off episodes.",
  "sections": [
    {
      "heading": "Summary findings",
      "content": "- EM short-term Covered Interest Parity (CIP) deviations exhibit much larger volatilities than most G10 currencies.\n- EM CIP deviations move in an opposite direction during global risk-off episodes.\n- Offshore EM CIP deviations are sensitive to changes in FX dealers’ risk-bearing capacities and global risk aversion.\n- Onshore EM CIP deviations are largely unresponsive in segmented FX markets.\n- For currencies with segmented FX markets, the sensitivity of offshore CIP deviations to global risk factors is stronger compared to currencies with integrated FX markets.\n- After accounting for global factors, there is weak evidence that country default risk affects EM CIP deviations."
    },
    {
      "heading": "Determinants and mechanisms",
      "content": "- Global risk aversion: a key global factor influencing offshore EM CIP deviations.\n- FX dealers’ risk-bearing capacity: changes in dealers’ capacity materially affect offshore CIP deviations.\n- Market segmentation: onshore markets that are segmented show muted responses of CIP deviations to the global drivers that affect offshore markets."
    },
    {
      "heading": "Distinctions across market segments",
      "content": "- Offshore vs onshore:\n  - Offshore CIP deviations: responsive to global risk factors and dealers’ risk-bearing capacities.\n  - Onshore CIP deviations: largely unresponsive where FX markets are segmented.\n- Segmented vs integrated FX markets:\n  - Currencies in segmented markets: offshore deviations show stronger sensitivity to global risk factors than currencies in integrated markets."
    },
    {
      "heading": "Evidence on country default risk",
      "content": "- Once global factors are controlled for, country default risk provides only weak explanatory power for EM CIP deviations."
    },
    {
      "heading": "Key takeaways for policymakers and market participants",
      "content": "- Monitoring global risk aversion and FX dealers’ risk-bearing capacity is crucial for understanding offshore EM CIP deviations.\n- Market segmentation alters how onshore CIP deviations respond to global shocks; reforms toward greater integration could change these dynamics.\n- Assessments of country default risk should account for dominant global drivers when evaluating their role in CIP deviations.\n\nIMF Working Paper by Eugenio M Cerutti and Haonan Zhou, February 10, 2023.\n\n---\n\n Content in this bundle\n\n- Working Paper\n  - Working Paper (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Working Paper (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2023/02/10/uncovering-cip-deviations-in-emerging-markets-distinctions-determinants-and-disconnect-529681"
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    "Authors: Eugenio M Cerutti, Haonan Zhou",
    "Published: February 10, 2023",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9798400237003.001",
    "EM short-term Covered Interest Parity (CIP) deviations exhibit much larger volatilities than most G10 currencies.",
    "EM CIP deviations move in an opposite direction during global risk-off episodes.",
    "Offshore EM CIP deviations are sensitive to changes in FX dealers’ risk-bearing capacities and global risk aversion.",
    "Onshore EM CIP deviations are largely unresponsive in segmented FX markets.",
    "For currencies with segmented FX markets, the sensitivity of offshore CIP deviations to global risk factors is stronger compared to currencies with integrated FX markets.",
    "After accounting for global factors, there is weak evidence that country default risk affects EM CIP deviations.",
    "Global risk aversion: a key global factor influencing offshore EM CIP deviations.",
    "FX dealers’ risk-bearing capacity: changes in dealers’ capacity materially affect offshore CIP deviations.",
    "Market segmentation: onshore markets that are segmented show muted responses of CIP deviations to the global drivers that affect offshore markets.",
    "Offshore vs onshore:",
    "Segmented vs integrated FX markets:",
    "Once global factors are controlled for, country default risk provides only weak explanatory power for EM CIP deviations.",
    "Monitoring global risk aversion and FX dealers’ risk-bearing capacity is crucial for understanding offshore EM CIP deviations.",
    "Market segmentation alters how onshore CIP deviations respond to global shocks; reforms toward greater integration could change these dynamics.",
    "Assessments of country default risk should account for dominant global drivers when evaluating their role in CIP deviations.",
    "**Working Paper**"
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