Covered Interest Rate Parity and Efficiency
of Foreign Exchange Market in India:
An Econometric Investigation
Article Details
Pub. Date
:
June, 2017
Product Name
:
The IUP Journal of Financial
Risk Management
Product Type
:
Article
Product Code
:
IJFRM21706
Author Name
:
Suman Sikdar and C K Mukhopadhyay
Availability
:
YES
Subject/Domain
:
Finance Management
Download Format
:
PDF Format
No. of Pages
:
21
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Abstract
The study is devoted to examining the ‘efficiency’ of Indian foreign exchange (rupee/dollar) market and the relevance of Covered Interest Rate Arbitrage Parity (CIRAP) doctrine therein over the period January 3, 2011 through November 2, 2015. ARIMA (4, 1, 0) stochastic structure of monthly spot rate (st) has been used to generate one-period ahead forecast (set+1) series. These forecasts are Minimum Mean Square Error (MMSE) forecasts and ‘rational’ by nature. Forward rates (tFt+1) served as the ‘unbiased predictor’ of the spot rate (st+1) implying that CIRAP did hold well in the market. Again absence of ‘risk premium’ testifies to the efficiency of the Indian foreign exchange (rupee/dollar) market over the period of study.
Description
The decade of 1970s brought in a turning point in the realm of international economics and finance. The Bretton Woods System broke down and flexible exchange rate system replaced the fixed exchange rate system in the 1970s. Determination of exchange rates became the centerpiece of deliberations in international economics, while the management of balance of payments became almost a nonentity. Consequently, over the last three decades, a large number of theories on exchange rate grew. On the other hand, the issues of dynamic adjustment of balance of payments were relegated to the background.
The most exciting feature of this period is the growth of renewed interest of economists in the ‘Interest Arbitrage Parity Doctrine’ and thus the ‘Interest Rate Arbitrage Parity Theory’ has emerged as an influential theory of the determination of the exchange rate since the 1970s.
interest rate arbitrage parity theory is theoretically attractive but the empirical support for the theory is mixed. Yet the research on this subject is extensive which indicates that there exists a reluctance for rejecting the theory, at least in the short run. The present study is an attempt in this direction with an objective of examining how far the rupee/dollar exchange rates conformed to the interest rate arbitrage parity doctrine over the period January 3, 2011 through November 2, 2015.
