# When calculating CIP between EU and US, which interest rates data to use?

I am wondering which data to use to test the Covered Interest Rate Parity between Europe and the United States. Recap that for the CIP to hold, it should mean that

F/S = (1+r)/(1+r*) where

• F = the 1-period ahead forward rate on the EUR/USD exchange rate
• S = the spot rate of the EUR/USD exchange
• r = domestic interest rate
• r* = foreign interest rate

For the forward rate I use the 1-month rates available on many resource sites, this holds true for the spot rate. However, which interest rate should I use for the domestic and foreign one?

My guess was to use the Euribor (1-Month) for the European and the Daily Treasury Yield (1-Month) or the USD Libor (1-Month).

However, then there is a huge gap between F/S and (1+r)/(1+r*); i.e. F/S yields values around 0.9-0.95 whereas (1+r)/(1+r*) yields values around 0.5 (when using USD Libor), meaning that the CIP definitely does not hold.

Recap that the lastest rate on the T-bill (1-Month) equals 0.03 and USD libor 0.1992 whereas the Euribor (1-Month) equals 0.112. Also recap that the forward rate (1-month) on EUR/USD is about 1.25 and the spot rate about 1.31.

An explanation could be of course the absence of transaction costs, but does this explain such a large gap? And secondly, if I wanted to calculate the CIP with transaction costs, does anybody know where to get the BID and ASK quotes on the Euribor and Treasury Bill?

In summary: - Which interest rate should I use for Europe and US? - Why is there such a large gap? - Where to get the BID and ASK quotes on the Euribor and T-bill?

Thank you.

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Your 1 month forward rate is wildly wrong (based on Bloomberg FRD command). I suspect that if you got 0.04 for that ratio, then you're also doing something wrong in that calculation as well (you're right to use 1 month rates). At a minimum, you need to account for the fact that you are only investing over a one month period (instead of a year). –  John May 9 '13 at 13:46
@John Thanks for the quick response. The forward rate was indeed wrong (1.2 bid and 1.3 ask). For the calculation I still haven't figured out what the issue is. However, when using the USD libor instead of the Treasury bill, I do get a ratio around 0.5 (the ratio F/S is arround 0.9). I found an article (still working paper though, see: Coffrey, Hrung and Sarker (2009)) that finds evidence of CIP deviations after the financial crisis. –  JohnAndrews May 9 '13 at 14:31
You F/S is still off, but not as off. The ratio is also way off. You have to use interest rates as a percent, so 6bps is $0.06/100$ and you also have take into account that you are only investing over a limited period. I got significantly closer numbers. –  John May 9 '13 at 14:43
Can you clarify the latest - to take into account that you invest over a limited period - ? Do you get closer numbers with USD Libor or the T-Bill? –  JohnAndrews May 9 '13 at 14:46
As in en.wikipedia.org/wiki/Compound_interest. If you set up the math properly, you will get a difference between the two, but it will be nowhere near as large as the differences you are reporting. –  John May 9 '13 at 16:31