1 / 7

Recap : UIP, PPP, and Exchange Rates

Recap : UIP, PPP, and Exchange Rates. Roberto Chang February 2012. Covered Interest Parity. A consequence of arbitrage It provides a link between interest rates , the spot exchange rate , and the forward exchange rate : 1 + i $ = (1+i € )*(F $/€ /E $/€ ).

snowy
Download Presentation

Recap : UIP, PPP, and Exchange Rates

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Recap: UIP, PPP, and Exchange Rates Roberto Chang February 2012

  2. CoveredInterestParity • A consequence of arbitrage • Itprovides a link betweeninterestrates, the spot exchangerate, and theforward exchangerate: 1 + i$= (1+i€)*(F$/€ /E$/€)

  3. UncoveredInterestParity • Basedontheassumptionthatinvestorscareonlyaboutexpectedreturns • Gives a link betweeninterestrates, the spot exchangerate, and theexpectedfutureexchangerate: 1 + i$= (1+i€)*(Ee$/€ /E$/€)

  4. From UIP to a Theory of Exchange Rates • From UIP, 1 + i$= (1+i€)*(Ee$/€ /E$/€) weget E$/€ = Ee$/€ *(1 + i$ )/ (1+i€) • Thissaysthatweunderstandthecurrentexchangerateifweunderstandinterestratesand theexpectedfutureexchangerate.

  5. Law of One Price • The LOOP saysthat a particular goodmustsell at thesameprice in differentlocations, whenthepriceisquoted in a commoncurrency: Pjeans,$ = Pjeans,€*E$/€

  6. PurchasingPowerParity • PPP islike LOOP butappliedtobaskets of goods and services (i.e. thetypicalconsumerbasket): P$ = P€*E$/€ • Theprice of thesaidbasketsisusuallywhatwe mean bythepricelevel. • PPP is a reasonableassumptionaboutthelongrun

  7. From PPP to Long Run Exchange Rates • From PPP, P$ = P€*E$/€ onegets E$/€ = P$/ P€ • Hencethe (longrun) exchangerateisgivenbythe (longrun) ratio of pricelevels. • Nextquestion: what determines pricelevels?

More Related