Interest Parity

Interest Parity

A situation in which the interest rates in two currencies are equal because of differences in their exchange rates. For example, if the U.S. dollar has a 4% interest rate and the British pound has a 5% interest rate, but the exchange rate difference is 1%, the dollar and the pound are said to have interest parity.
References in periodicals archive ?
The empirical work abstracts from well-known difficulties with uncovered interest parity, assuming that whatever shocks to interest parity occurred during the sample would have also occurred had the Bank been following an alternative interest rate policy.
2) He introduces simple, but very clear, financial investor arbitrage behavior that seeks the highest global expected rate of return so that, at the equilibrium, the interest parity condition (3) must hold.
The theory of uncovered interest parity says that the currency of a country with high interest rates is expected to decline by an amount equal to the differential in rates over a horizon equal to the rates' maturity.
The court also said in light of the concerns expressed in the comment of the Florida Bankers Association, the final rule was clarified to reflect the intent that there be interest parity between IOTA accounts and non-IOTA accounts held in the same financial institution.
Uncovered interest parity says that the expected rate of change of the nominal exchange rate equals the difference in nominal interest rates across countries.
Table 1 presents five measures used in the literature to quantify the degree of capital mobility - (i) covered interest rate parity (CIP), (ii) uncovered interest parity (UIP), (iii) real interest rate parity (RIP), (iv) saving-retention coefficient (Feldstein and Horioka 1980), and (v) the offset coefficient (Argy and Kouri 1974 and Kouri and Porter 1974).
Sufficient conditions for the emergence of such an international financing mix are derived as functions of international interest parity relations and covariances of project's cash flows with state contingent misalignments of pure security prices and exchange rates.
This is consistent with "uncovered interest parity," which says that movements in interest differentials are offset exactly by changes in expected depreciation.
There are feedback mechanisms limiting this influence, however, which can be set out by analysing the implications of the uncovered interest parity condition for any departure of the exchange rate from its purchasing power parity value as a result of a temporary policy-induced change in the domestic interest rate.
Future exchange rate movements might be linked to differences in two currencies' interest rates through a construct called uncovered interest parity (UIP), which says that a market in equilibrium must expect the currency with higher interest rates to depreciate and so equalize expected rates of return in the two currencies.
The objective of this note is to shed some light on these issues and to present empirical evidence on capital mobility based on real interest parity.