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Open Access Publications from the University of California

The Capital Control Effect On The Failure Of Covered Interest Parity In Asian Markets

  • Author(s): Ge, Qing
  • Advisor(s): Hutchison, Michael
  • et al.

This dissertation investigates factors related to the failure of covered interest parity by focusing on seven Asian emerging economies where they have both onshore deliverable forward and offshore non-deliverable forward. It implements the deviation from covered interest parity (CID) to proxy the capital control risk as to the primary risk factor and other subsequent risk factors. Among these seven countries and three types of forward maturities, capital control has a positive effect on the carry trade return, especially the strategy using onshore deliverable forward. The results are relevant to those emerging countries as they manage their capital flow and protect currency crashes.

The second part constructs an extended daily capital control index from Oct. 2010 to July 2019 and collect PBoC interventions for the same period to measure the failure of CID in China onshore and offshore markets. It finds that the level of CIDs of China FX markets is positively related to the capital control restrictions but not the government intervention. However, by applying an extended GARCH model, the volatilities of the CID are reduced by direct and indirect government interventions.

In the last part, my coauthor Penghao Cheng and I implement a model to explore Chinese onshore and offshore financial markets and fill the gap of the term spread differential of money market and CIP violation of currency market spillover effects. The empirical test uses

a new flexible econometric method - Bayesian local projections. This Bayesian method can sensibly reduce the impact of compounded biases over the horizons and effectively deal with model misspecifications.

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