International Parity Conditions Research Proposal

International Parity Conditions - Research Proposal Example The degree of real interest rate parity depends on the scope of uncovered interest parity and relative purchasing power parity. Actually, uncovered interest parity denotes financial investment between money and foreign exchange markets. The relative purchasing power parity means investment in goods and services. Thus the real interest parity condition embraces components of both real and financial integration. According to Roll (1979), under the efficient market assumption, ex ante-attention from purchasing power parity are unpredictable. (Frankel, 1991), for instance, proposes that breach of ex-ante relative purchasing power parity is linked with an uncompleted combination of goods markets. capital is open to shifting. For example, an optimal firm fixes its marginal product of capital equal to the consumer cost of capital. The consumer cost of capital is nominal interest rate (without considering taxes and depreciation) attuned to the rate of inflation of its output. Thus the real interest parity is a signal to the equalization of the marginal product of capital. A refinement is drawn in using parity conditions to assess integration. That is, if a parity condition is discarded, then expansions and reductions of differences may happen as a result of either more economic integration or greater union of economic policies, or both. differentials and the coefficient figures are applied to evaluate whether the real interest rate parity condition holds. There is an extensive literature on testing real interest parity according to (Mishkin (1984), Mark (1985), and Cumby and Mishkin (1986)). Example: U.S. investor has $1 to invest, say for one year.   Here, two strategies are to be considered: 1) Investment in U.S. Treasury securities at $, at the domestic interest rate, or 2) Invest U.K. treasury securities at i £, and hedge FX risk by selling maturity value of  £s forward one year.