Real Interest Rate Parity
When both UIRP (particularly in its approximation form) and purchasing power parity (PPP) hold, the two parity conditions together reveal a relationship among expected real interest rates, wherein changes in expected real interest rates reflect expected changes in the real exchange rate. This condition is known as real interest rate parity (RIRP) and is related to the international Fisher effect. The following equations demonstrate how to derive the RIRP equation.
where
- represents inflation
If the above conditions hold, then they can be combined and rearranged as the following:
RIRP rests on several assumptions, including efficient markets, no country risk premia, and zero change in the expected real exchange rate. The parity condition suggests that real interest rates will equalize between countries and that capital mobility will result in capital flows that eliminate opportunities for arbitrage. There exists strong evidence that RIRP holds tightly among emerging markets in Asia and also Japan. The half-life period of deviations from RIRP have been examined by researchers and found to be roughly six or seven months, but between two and three months for certain countries. Such variation in the half-lives of deviations may be reflective of differences in the degree of financial integration among the country groups analyzed. RIRP does not hold over short time horizons, but empirical evidence has demonstrated that it generally holds well across long time horizons of five to ten years.
Read more about this topic: Interest Rate Parity
Famous quotes containing the words real, interest, rate and/or parity:
“What might be taken for a precocious genius is the genius of childhood. When the child grows up, it disappears without a trace. It may happen that this boy will become a real painter some day, or even a great painter. But then he will have to begin everything again, from zero.”
—Pablo Picasso (1881–1973)
“President Kennedy had a wholesome, widely discussed, and largely deserved reputation for his interest in women.... But no President, however young and energetic, could possibly have gotten around to all the ladies in Washington, New York, and Hollywood who made claim to his affections after he died.... Such was the force of Jack Kennedy and the manner of his death that anyone associated with him, even the pretenders, assumed added glamour and interest.”
—Barbara Howar (b. 1934)
“Whoever thinks his friend more important than his country, I rate him nowhere.”
—Sophocles (497–406/5 B.C.)
“The U.S. is becoming an increasingly fatherless society. A generation ago, an American child could reasonably expect to grow up with his or her father. Today an American child can reasonably expect not to. Fatherlessness is now approaching a rough parity with fatherhood as a defining feature of American childhood.”
—David Blankenhorn (20th century)