Both these subcomponents of the interest rate parity
theory state that, in a context characterized by a free flow of capital, it's impossible to make profits by following the above mentioned strategies, as the offer and demand mechanism will ensure that the forward or future spot quotations will imply an appreciation of the currency with a relatively smaller interest rate, appreciation that, ceteris paribus, will be equal to the difference between the initial and the modified levels of the interest rate (6), thus annulling any potential profits and delivering an equivalence between investments made in one currency or another.
Our strategy, involve constructing multiple series of trade-weighted industry-specific real exchange rates and investigate whether the uncovered real interest rate parity
holds for 18 industries ranging from the more consumer-oriented, such as furniture and fixtures, to more intermediate and primary levels such as plastics and chemicals.
A study conducting empirical investigation based on CPI-based real interest rates is used to conclude that real interest rate parity
is not supported in a paper by Lin Wu and Lin Chen (Wu & Chen, 2007).
According to uncovered interest rate parity
, it is predicted that currencies yielding a high return will depreciate; however, an increase in real interest rate will appreciate the currency.
The theory of Interest Rate Parity
holds that one cannot make arbitrage profit by speculating in foreign exchange market due to different interest rate in different countries.
First, that interest rate parity
holds mostly between U.
Observation of the foreign and domestic interest rates and the exchange rate serves to reveal, from the interest rate parity
condition, the expectation of informed agents about the one period ahead exchange rate, E([S.
3) The implication is that the purchasing power parity condition is likely to be strongly related to the uncovered interest rate parity
cogency of the argument based on the interest rate parity
2003) analyze various aspects of integration of some recently joined countries with the European Union in a model in which interest rate parity
is part of the nominal exchange rate equation.
For many of us, we learned that the international transmission of monetary policy occurs through mechanisms meant to achieve interest rate parity
or purchasing power parity across borders in the medium term.
In analyzing exchange rate movements, one important concept is uncovered interest rate parity
(UIP), by which the movement in the exchange rate expected by the market must equal the interest rate differential between the two countries.