The Implications of Covered Interest Parity for Short-Term Financing: Testing Some Underlying Hypotheses

Covered interest parity (CIP) is tested indirectly by using its implication that foreign currency financing, while covering the position in the forward market, is equivalent to domestic (base) currency financing. Two derived hypotheses are also tested. The first is that if CIP holds then the effective financing rates in the two currencies will be equal only if the nominal interest rates are equal. The second is that this equality holds even if CIP is violated, provided that the violation follows a certain condition. The results are mixed, as some observed deviations from CIP are attributed to measurement errors and some similar factors.