What is new about covered interest parity condition in the European Union? Evidence from fractal cross-correlation regressions

Abstract

We analyse the covered interest parity (CIP) using two novel regression frameworks based on cross-correlation analysis (detrended cross-correlation analysis and detrending moving-average cross-correlation analysis), which allow for studying the relationships at different scales and work well under non-stationarity and heavy tails. CIP is a measure of capital mobility commonly used to analyse financial integration, which remains an interesting feature of study in the context of the European Union. The importance of this features is related to the fact that the adoption of a common currency is associated with some benefits for countries, but also involves some risks such as the loss of economic instruments to face possible asymmetric shocks. While studying the Eurozone members could explain some problems in the common currency, studying the non-Euro countries is important to analyse if they are fit to take the possible benefits. Our results point to the CIP verification mainly in the Central European countries while in the remaining countries, the verification of the parity is only residual.