Covered interest parity and international capital market efficiency

Tests of covered interest parity (CIP) are prevalent in the economics and finance literature. These studies demonstrate that there does exist some profitable deviations of exchange rates and interest rates from the equilibrium implied by CIP. Unfortunately, no conclusions regarding market efficiency can be drawn from such evidence since efficient markets do not preclude profitable deviations, only the persistence of such deviations. This study uses impulse response analysis on the CIP equilibrium of daily exchange rates and interest rates in order to analyze the persistence of arbitrage profits. The results suggest that risk free profits persist longer that can be reconciled with market efficiency. JEL Classifications: F31, F41, C32 .