THE DARK MARKET OF FOREIGN EXCHANGE THE POWER OF PURCHASING POWER PARITY

Open Access
Author:
Albano, Maria Christine
Area of Honors:
Economics
Degree:
Bachelor of Arts
Document Type:
Thesis
Thesis Supervisors:
  • Jonathan W Eaton, Thesis Supervisor
  • David Shapiro, Honors Advisor
Keywords:
  • foreign exchange
  • purchasing power parity
  • market exchange rates
  • purchasing power parity puzzle
Abstract:
This thesis is an examination of foreign exchange markets, purchasing power parity and the exchange rates these two measures yield. An overview of the financial markets sets the tone of the first section of the thesis in which examples are given to show the derivation of market exchange rates. In section one, the foreign exchange market, market exchange rates and three currencies are defined and investigated. The overall magnitude of the forex market, the largest market in the world, is clearly defined throughout section one. The thesis continues on to section two where the concept of purchasing power parity is defined and derived mathematically. Following the initial discussion of PPP, the theoretical and relative PPP exchange rates are investigated. The two sections are then brought together with the concept of the law of one price and arbitrage. An ending hypothesis about the drastic difference between the market exchange rate and the theoretical PPP derived exchange rate being the fault of a lack of arbitrage in the global marketplace is made.