Reinvestigating the interest rate parity – IBOR reform and its implications
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Journal Title
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Volume Title
School of Business |
Master's thesis
Authors
Date
2023
Department
Major/Subject
Mcode
Degree programme
Finance
Language
en
Pages
51
Series
Abstract
In this thesis, the IBOR reform and its implications on the cross currency basis and Covered Interest Rate Parity (CIP) are studied with recent swap curve data and data from EURUSD cross-currency basis quotes. By analysing the reform, it is concluded that the transition can impact the cross- currency basis because term-rates no longer exist in all jurisdictions, and the new overnight Alternative Reference Rates (ARR’s) can differ in their level and behaviour when compared to their Interbank Offered Rate (IBOR) predecessors. Based on recent swap curve data during and after the reform for EUR, USD, GBP and CHF, it can be evident that there is a significant basis (level difference) between the ARR based OIS curves and now largely retired IBOR-based IRS curves. This level difference between OIS and IRS rates can be witnessed to spill over into the cross-currency basis, when comparing cross-currency basis quotes for cross- currency swaps that exchange overnight (ARR) rates to cross-currency swaps that exchange 3-month IBOR rates. In EURUSD the basis quoted for ARR (ESTR vs. SOFR) exchanging swaps can be deemed significantly wider (more negative) than the basis that is quoted for 3-month exchanging swaps (Euribor vs. USD LIBOR). Implying that after the reform, CIP deviations still exist and can be even more significant when they are measured based with the more risk-free ARR based rates and curves.Description
Thesis advisor
Puttonen, VesaKeywords
covered interest rate parity, IBOR reform, cross-currency basis, cross-currency swaps, FX forward rates, interest rate swaps, overnight index swaps, alternative reference rates