Global CIP Deviation Factor

This paper examines the dynamics of Covered Interest Parity (CIP) deviations in G10 currencies. Using a dynamic factor model, we document the existence of a common global factor structure in CIP deviations across G10 currencies, suggesting these violations are driven by systematic global forces. Our findings reveal that the TED spread, a measure of global funding liquidity, emerged as the dominant factor in explaining CIP deviations during crisis periods through 2017, while the Real Dollar Index showed significant explanatory power during 2013-2017. Notably, we document a recent structural shift where the global CIP factor has become less responsive to traditional predictors, maintaining historically low levels. While substantial CIP deviations were observed during periods of market stress, our analysis suggests the estimated global factor of CIP deviations has maintained historically low levels in recent years.