Shapiro Chapter 4 (3)

Shapiro Chapter 4 (3) - CHAPTER4 PARITY CONDITIONS AND...

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CHAPTER 4 PARITY CONDITIONS AND CURRENCY FORECASTING
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ARBITRAGE AND THE LAW OF ONE PRICE I. THE LAW OF ONE PRICE A. Law states: Identical goods sell for the same price worldwide. 2
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ARBITRAGE AND THE LAW OF ONE PRICE B. Theoretical basis: If the prices after exchange-rate adjustment were not equal, arbitrage for the goods worldwide ensures that eventually they will. 3
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ARBITRAGE AND THE LAW OF ONE PRICE C. Five Parity Conditions Result From These Arbitrage Activities 1. Purchasing Power Parity (PPP) 2. The Fisher Effect (FE) 3. The International Fisher Effect (IFE) 4. Interest Rate Parity (IRP) 5. Unbiased Forward Rate (UFR) 4
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ARBITRAGE AND THE LAW OF ONE PRICE D. Five Parity Conditions Linked by 1. The adjustment of various rates and prices to inflation 2. The notion that money should have no effect on real variables (since they have been adjusted for price changes) 5
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ARBITRAGE AND THE LAW OF ONE PRICE E. Inflation and home currency depreciation: 1. jointly determined by the growth of domestic money supply 2. relative to the growth of domestic money demand 6
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ARBITRAGE AND THE LAW OF ONE PRICE F. THE LAW OF ONE PRICE - enforced by international arbitrage. 7
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PURCHASING POWER PARITY I. THE THEORY OF PURCHASING POWER PARITY: states that spot exchange rates between currencies will change to the differential in inflation rates between countries. 8
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PURCHASING POWER PARITY II. ABSOLUTE PURCHASING POWER PARITY A. Price levels adjusted for exchange rates should be equal between countries 9
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II. ABSOLUTE PURCHASING POWER PARITY B. One unit of currency has same purchasing power globally. 10
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This note was uploaded on 02/22/2011 for the course BMGT 446 taught by Professor Staff during the Spring '08 term at Maryland.

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Shapiro Chapter 4 (3) - CHAPTER4 PARITY CONDITIONS AND...

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