International Parity Conditions

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"Prices, Interest Rates, and Exchange Rates in Equilibrium" (International Parity Conditions)

Table of Content

Executive Summary………………………………………………………3 1.Introduction………………………………………………………….4 2.Literature Review……………………………………………………6 3.Findings and Analysis: ………………………………………………10 a.PPP………………………………………………..…………10

b.FE……………………………………………..……………..12
c.IFE…………………………………………..……………….14
4.Conclusion & Recommendations …………….……..………………16 Bibliography……………………………………………………………….17 Appendix A. Historical Data………………………………………………18

Table of Figures

Figure 1. International Parity Conditions
Figure 2. Scatter Diagram for PPP
Figure 3. Time-series data for inflation rates differential and exchange rate change Figure 4. Regression Plot for PPP
Figure 5. Scatter Diagram for FE
Figure 6. Time-series data for inflation and interest rates differentials Figure 7. Regression Plot for FE
Figure 8. Scatter Diagram for IFE
Figure 9. Time-series data for interest rates differentials and exchange rate change Figure 10. Regression Plot for IFE
Executive Summary

This assignment is aimed at examining the evidence for three of the relationships that underpin (explicitly or implicitly) much of international macroeconomics. The first is purchasing power parity (PPP), or the hypothesis that there exists a constant long-run equilibrium real exchange rate. The second is Fisher Effect, which tests the relationship between difference in inflation rates and difference in nominal interest rates. The third establishes a relationship between real exchange rates and real interest rate differentials or International Fisher Effect. The tests are conducted on a basis of two economies: United States and Kazakhstan. The results are obtained using graphs and regression models, which significantly increase the power of the tests. The empirical evidence is evaluated on the basis of historical data for the period of 1999-2003. The paper is divided into two main parts. The first part contains analysis of the historical data about interest rates, exchange rates, and 3-month T-bills (Kazakhstani name: MEKKAM) in two countries: Kazakhstan and USA. The second part gives implications based on the results of analysis.

Introduction
The core of international finance theory lies in international parity conditions. They bring together prices, interest rates, and exchange rates. As expected rate of change in the spot exchange rate, differential rates of national inflation and interest, forward discount or premium are all interrelated, a change in one of them leads to a change in all the rest, so that the first variable changes again.

In our work we test whether International Parity Conditions hold in the context of the Kazakhstani economy. In our research we intend to examine the theory of Purchasing power parity, Fisher effect, International Fisher effect, Interest rate parity, and Forward rate as an unbiased predictor of the future spot rate. Scope of the study

For the purposes of this study we obtain time series data on the American and Kazakhstani interest rates, inflation rates, and exchange rate statistics on quarterly basis for five years (1999-2003). Limitations

In this paper we consider parity conditions between US and Kazakhstan. Kazakhstani Stock Exchange doesn't trade forward contracts; therefore we are not able to test such conditions as forward rate as unbiased predictor of the future spot rate and interest rate parity. Furthermore, some months T-bills were not issued, that's why we will omit these months in our analysis. Significance of the study

The study represents an empirical evidence of international parity conditions. It helps explain the long run trend in an exchange rate. This study will help to understand how multinational business is conducted and financed.

Literature review
Alan Shapiro in "Multinational Financial Management" affirms that there are five parity conditions resulted from arbitrage activities...
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