Covered arbitrage in foreign exchange markets with forward forward contracts in interest rates: Comment

✍ Scribed by Batlin, Carl A.

• Publisher: John Wiley and Sons
• Year: 1999
• Tongue: English
• Weight: 110 KB
• Volume: 19
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/(sici)1096-9934(199902)19:1<115::aid-fut6>3.0.co;2-j

✦ Synopsis

In a recent issue of this Journal, 1 Dilip Ghosh confuses the concept of a (known) forward interest rate with that of a (random) future short-term interest rate. As a result, both of his main conclusions-that combining interest rate forwards with foreign exchange (FX) forwards produces a new version of the Interest Rate Parity Theorem (IRPT), and that a sufficient condition for its validity is the Pure Expectations Hypothesis (PEH) of the term structure of interest rates-are invalid.

The traditional version of IRPT states that if investors can borrow or lend 6-month funds at 0 R 2 domestically and at in a foreign market, R* 0 2 then covered interest arbitrage will ensure that the relationship between