The Double Covered Question - Do Swedish Covered Bonds Adhere to the Covered Interest Parity

Abstract: This thesis looks at the adherence of Swedish covered bonds to the Covered Interest Parity theorem by performing an original data study. In the study real trading data from the Royal Bank of Scotland with matched swaps from ICAP are used. We test the hypothesis that the theory of Covered Interest Parity holds and whether this has changed in wake of the recent financial crisis. After rejecting this hypothesis we analyse if the observed deviations can be explained by liquidity, as suggested in previous research, using the nominal weekly turnover for covered bonds as a proxy. We then search for an alternative explanation for the deviations and are able to show that the price of the cross-currency basis swap has a substantial explanatory power with significance at the 1% level. Based on this a relative measure of adherence is analysed, benchmarking the covered bonds towards government bonds, to exclude the effect from the cross-currency swap. In this setting a clear trend favouring the covered bonds is observed and a strong explanatory power can be attributed to the liquidity, now defined as the relative turnover of covered bonds compared to total turnover of covered and government bonds.