International Parity Conditions

International Parity Conditions - CLASS MATERIALS...

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CLASS MATERIALS INTERNATIONAL PARITY CONDITIONS ---------------------------------------------------- 1. Key Interest Rate-Exchange Rate Linkages: The Parity Framework Parity conditions are useful when parity holds Parity conditions are useful when parity does not hold 2. Purchasing Power Parity: Theory and Evidence Theory of purchasing power parity PPP and real exchange rates Empirical methods effect our empirical findings about PPP Evidence about PPP in the short-run Evidence about PPP in the long-run (Is there mean reversion ?) 3. Interest Rate Parity: Theory and Evidence Theory of Interest Rate Parity Interest Rate Parity and covered interest arbitrage flows Empirical methods effect our empirical findings about IRP The choice of securities effects our empirical findings about IRP Opportunities for 'one-way' arbitrage even when IRP does not hold Interest Rate Parity for long-dated maturities 4. Uncovered Interest Parity (Fisher International Effect): Theory and Evidence Theory of interest rates and exchange rate changes in the short run Empirical methods effect our empirical findings about UIP Empirical evidence on UIP in the long-run and in emerging markets 5. Forward Rate Unbiased Property: Theory and Evidence Theory of forward rates and expected future spot rates Empirical evidence on unbiasedness ---------------------------------------------------- Richard M. Levich New York University
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FIGURE 4.1 PARITY RELATIONSHIPS IN INTERNATIONAL FINANCE THEORY IN WORDS IN SYMBOLS DRIVING FORCES Purchasing Power Parity Absolute Version The price of a market basket P $ = P DM x Spot Arbitrage in goods of US goods equals the price of a market basket of foreign goods when multiplied by the exchange rate Relative Version The percentage change in the exchange ? Spot = ? P $ - ? P DM Arbitrage in goods rate equals the percentage change in US goods prices less the percentage change in foreign goods prices Interest Rate Parity The forward exchange rate premium (F - S)/S = i $ - i DM Arbitrage between equals (approximately) the US interest the spot and forward rate minus the foreign interest rate exchange rates Fisher Parities Fisher Effect For a single economy, the nominal i $ = r $ + E(?P $ ) Desire to insulate (Fisher Closed ) interest rate equals the real interest the real interest plus the expected rate of inflation against expected inflation. Arbitrage between real and nominal assets. International For two economies, the US interest rate i $ - i DM = E( ? Spot) Arbitrage in bonds Fisher Effect minus the foreign interest rate denominated in two (Fisher Open) equals the expected percentage currencies change in the exchange rate Forward Rate Unbiased Today's forward premium (for (F t - S t )/S t = Market players monitor the delivery in n days) equals (E(S t+n ) - S t )/S t difference between today's the expected percentage forward rate (for delivery change in the spot rate (over in n days) and their
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International Parity Conditions - CLASS MATERIALS...

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