《国际金融实务英语》课程教学课件（PPT讲稿）Chapter 5 Models of Exchange-rate Determination

Chapter5Models of theforeignexchangedetermination

Chapter 5 Models of the foreign exchange determination

5.1PurchasingpowerparityThe theory linking inflation and exchangerate movements is knownaspurchasingpowerparity (PPP)

5.1 Purchasing power parity  The theory linking inflation and exchange rate movements is known as purchasing power parity (PPP)

ThelawofonepriceoThetheoryofPPpisbasedonthelawofoneprice (LOP).The law of one price states that identicalcommodities or goods must have the sameprice in all markets

The law of one price  The theory of PPP is based on the law of one price (LOP).  The law of one price states that identical commodities or goods must have the same price in all markets

Absolute andrelativePPPPGBp(O) = Pusp(O)S。(GBP / USD)This relation represents the absolute form ofPPP andis veryrestrictive

Absolute and relative PPP 0 (0) (0) ( / ) P P S GBP USD GBP USD =  This relation represents the absolute form of PPP and is very restrictive

R(0)S,(GBP / USD)PusD (t)S.(GBP / USD)(0)TherelativeformofPPP,morecommonlyused today,is less restrictive than theabsoluteform.o Itstatesthat incomparisonto aperiodwhenexchangerateswereineguilibriumchangesintheratioof domesticto foreignprices indicatethe appropriate adjustmentin the exchangerate

0 ( ) ( / ) (0) ( / ) ( ) (0) GBP t GBP USD USD P t S GBP USD P S GBP USD P t P =  The relative form of PPP, more commonly used today, is less restrictive than the absolute form.  It states that in comparison to a period when exchange rates were in equilibrium, changes in the ratio of domestic to foreign prices indicate the appropriate adjustment in the exchange rate

Theempirical evidenceoWhetherornotPPpholdsisanongoingcontroversy.Thereasonswhyitmightnothold are numerous.oThe strictest formof PPP reguiresthat:--financial marketsareperfectwithno controls,taxes,transactioncosts,etc;--goodsmarketsareperfectwithinternational shipmentofgoodsabletotakeplacefreely,instantaneouslyandwithout cost;--thereis a single consumptiongood commontoeveryone;--thesamecommoditiesappearinthesameproportions in each country's consumption basket

The empirical evidence  Whether or not PPP holds is an ongoing controversy. The reasons why it might not hold are numerous.  The strictest form of PPP requires that: - financial markets are perfect with no controls, taxes, transaction costs, etc; - goods markets are perfect with international shipment of goods able to take place freely, instantaneously and without cost; - there is a single consumption good common to everyone; - the same commodities appear in the same proportions in each country’s consumption basket

Reasons for divergence from short-term PPPoTheassetmarketapproachoOvershootingoTheportfoliobalanceapproach

Reasons for divergence from short-term PPP  The asset market approach  Overshooting  The portfolio balance approach

5.2CoveredinterestparityBackgroundTheClPconditiono Consider an investorwho has initial capital,K, and faces two alternatives:(i)domesticinvestment,wherebytheinvestorbuysdomesticassets,earningthedomesticinterestrate,i(ii)foreigninvestment,wherebytheinvestorconvertsthedomesticcurrencyintoforeigncurrencytobuyforeignassets,earningtheforeigninterestrate,i*

5.2 Covered interest parity Background The CIP condition  Consider an investor who has initial capital, K, and faces two alternatives: (i) domestic investment, whereby the investor buys domestic assets, earning the domestic interest rate, i; (ii) foreign investment, whereby the investor converts the domestic currency into foreign currency to buy foreign assets, earning the foreign interest rate, i*

The mechanics of covered arbitrageArbitragefromthedomesticcurrencytoaforeign currencyF(1+i*)-(1+i)元三Sorapproximatelyπ=i*-i+f

The mechanics of covered arbitrage  Arbitrage from the domestic currency to a foreign currency (1 ) (1 ) F i i S   = + − +  i i f  = − + or approximately

oArbitragefromaforeigncurrencytothedomesticcurrencyS(1+i)-(l+i*)元二Forapproximatelyπ=i-i-Theno-arbitrageconditionF

 The no-arbitrage condition 1 [ ] 1 i F S i  + = +  Arbitrage from a foreign currency to the domestic currency or approximately (1 ) (1 ) S i i F   = + − +  i i f  = − −