ch12 (3) - Uncovered Interest Parity (UIP) No arbitrage...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Uncovered Interest Parity (UIP) No arbitrage condition for expected returns States that the expected returns must be equal when expressed in a common currency We assume risk neutrality; e.g. that a risk neutral US investor does not care that the left hand side is certain, while the right hand side is risky. Uncovered Interest Parity (UIP) Knowing the expected exchange rate and the interest rates for each currency, we can solve for the spot exchange rate: Interest parity conditions CIP: UIP: Thus CIP plus UIP imply: Intuition: If investors do not care about risk, then they have no reason to prefer to avoid risk by using the forward rate rather than waiting for the expected future spot rate to materialize. An important testable implication: Left-hand side is the forward premium of Euros (+) or forward discount of Euros (–) Says how much more/less investors are willing to pay for the forward versus the spot rate. Right-hand side is
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 2

ch12 (3) - Uncovered Interest Parity (UIP) No arbitrage...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online