Paper The Implications of CIP Deviations for International Capital Flows

We study how deviations from covered interest rate parity affect international capital flows using novel data that combine euro-area FX derivatives with securities holdings statistics. Non-bank investors hedge nearly half of their USD exposures, primarily with short-term derivatives, creating a significant maturity mismatch with their bond holdings. Consistent with a currency-hedging channel, USD bond holdings decline following a widening of the USD–EUR cross-currency basis, especially for investors with larger hedging rollover needs. These bond-demand shifts significantly affect U.S. and euro-area bond prices. Our findings establish a new determinant of international capital flows with important consequences for financial stability.

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