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Covered Interest Parity and Interest Rate Parity in Foreign Exchange Markets

Explore the concepts of Covered Interest Parity and Interest Rate Parity in the foreign exchange market. Covered interest parity condition states that returns on dollar deposits and covered foreign deposits are equal. Empirical evidence supports this condition for various foreign currency deposits. Interest Rate Parity Theory explains equilibrium in the forex market when all currency deposits offer the same expected return.

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Covered Interest Parity and Interest Rate Parity in Foreign Exchange Markets

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  1. Covered Interest Parity • The covered interest parity condition states that the rates of return on dollar deposits and “covered” foreign deposits must be the same. • The interest rate on dollar deposits equals the interest rate on euro deposits plus the forward premium on euros against dollars.

  2. Empirical Evidence • Covered Interest Parity condition holds for different foreign currency deposits issued within a single financial center.

  3. Interest Rate Parity Theory • i=本国利率；i*=外国利率； • es=直接标价法下的即期汇率； • ef=直接标价法下的远期汇率； • (1+i)=一单位本币在国内投资到期所获收益； • =一单位本币投资国外到期收益； • 由于i*比1小得多，故

  4. Interest Rate Parity Theory The foreign exchange market is in equilibrium when deposits of all currencies offer the same expected rate of return.

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