A STATISTICAL ANALYSIS OF INTERNATIONAL EXCHANGE RATE FORMULAS

Open Access
Author:
Peslak, David Alexander
Area of Honors:
Interdisciplinary in Finance and International Business
Degree:
Bachelor of Science
Document Type:
Thesis
Thesis Supervisors:
  • Laura B Field, Thesis Supervisor
  • James Alan Miles, Honors Advisor
  • Terrence Robert Guay, Honors Advisor
Keywords:
  • International Finance
  • Exchange Rates
  • Interest Rate Parity
Abstract:
This research thesis analyzes four important international financial exchange rate formulas. Interest Rate Parity, Covered Interest Arbitrage, Uncovered Interest Arbitrage, and Purchasing Power Parity will be tested by statistically analyzing their exchange rates from Bloomberg over the course of the last twenty years. In theory, Interest Rate Parity should hold at all times. If IRP does not hold, there is a potential for significant arbitrage. In this case, the theories of Covered Interest Arbitrage and Uncovered Interest Arbitrage will be examined. In addition to these, Purchasing Power Parity will also be tested to see if it can determine the appropriate change in exchange rates based on the price of a basket of goods. Overall, the international financial formulas that were tested, for the most part, held true over the course of time. The greatest deviations were seen in the calculations of Uncovered Interest Arbitrage. This result was expected because Uncovered Interest Arbitrage has significant currency risk. Uncovered Interest Arbitrage does not lock in its potential profit with a forward rate, so its value is subject to the fluctuating spot exchange rates. These differences are magnified in the countries of Thailand and Mexico due to their developing economies. Other differences in the formulas are attributable to transaction costs, restrictive capital controls, and financial crises, such as the Mexican Peso Crisis of 1994, the Asian Financial Crisis of 1997, and the Subprime Mortgage Crisis of the late 2000s.