Artha Vijnana: Journal of The Gokhale Institute of Politics and Economics

Open Access Open Access  Restricted Access Subscription Access
Open Access Open Access Open Access  Restricted Access Restricted Access Subscription Access

Covered Interest Parity Arbitrage and Long-Run Relation between Spot and Forward Rates in Foreign Exchange (Rupee/Dollar) Market in India-Study of Market Efficiency with Arima (p, d, q) Forecasting


Affiliations
1 Department of Economics, KGT Mahavidyalaya, Bagdogra 734014, West Bengal, India
2 Department of Economics, University of North Bengal, Raja Rammohunpur 734014, West Bengal, India
     

   Subscribe/Renew Journal


The study examines the relation that spot exchange rate maintains with contemporaneous and one – month lagged forward rates in the framework of covered interest parity arbitrage in Indian foreign exchange (rupee/dollar) market from 3rd January, 2011 to 2nd November, 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 MMSE forecasts and ‘Rational’ by nature. The study shows that one – month lagged forward rate maintains an independent long – run stable relation with spot rate while there exists no co-integrating relation between spot rate and contemporaneous forward rate. One – period lagged forward rate is an optimal forecast of the next period spot rate in the sense that it will be proved wrong only to the extent ofa white noise error term. Risk premium is absent and CIRAP holds in the market such that lagged forward exchange rate on average equals the spot rate in the long – run. There exists no scope for reaping arbitrage profit arising out of the difference between forward rate and corresponding spot rate. This testifies for the ‘efficiency’ of Indian foreign exchange (rupee/dollar) market.
Subscription Login to verify subscription
User
Notifications
Font Size

  • Bhatti, Razzaque, H. Moosa, A. Imad (1995), An Alternative Approach to Testing Uncovered Interest Parity, Applied Economics Letters, 2(12): 478-781.

  • Browne, F.X. (1983), Departures from Interest Rate Parity: Further Evidence, Journal of Banking and Finance, 7(2): 253-272.

  • Clarida, R.H. and M.P. Taylor (1997), The Term Structure of Forward Exchange Premiums and the Forecast Ability of Spot Exchange Rates: Correcting the Errors, Review of Economics and Statistics, 79(3): 353-361.

  • Cumby, R.E. and M. Obstfeld (1984), International Interest Rate and Price Level Linkages Under Flexible Exchange Rate: A Review of Recent Evidence, in J.F.O, Bilson and R.C Marston (Eds.), Exchange Rate Theory and Practice, Chicago, University of Chicago Press.

  • Deepika Chandwani1, Manminder Singh Saluja (2014), Exchange Rate Relationship of India with Its Major Trading Partners: A Joint Testing Approach, International Journal of Econometrics and Financial Management, 2(6): 243-252.

  • Fama, Eugene F. (1984), Journal of Forward and Spot Exchange Rates, 14(3): 319-338.

  • Frankel, Jeffrey A., Kenneth Fischolar_main (1990), Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market, International Monetary Fund Working Paper, Working Paper No. WP/90/43, pages 26.

  • Hakkio, C.S. (1981), Expectations and the Forward Exchange Rate, International Economic Review, 22(3): 663-678.

  • Hansen, L.P. and R.J. Hodrick (1980), Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis, Journal of Political Economy, 88(5): 829-853.

  • James, R. Lothian, Liuren Wu (2011), Uncovered Interest-rate Parity over the Past Two Centuries, Journal of International Money and Finance, 30(2011): 248-274.

  • Jose, Olmo, Pilbeam Keith (2009), Uncovered Interest Parity: Are Empirical Rejections of It Valid?, Journal of Economic Integration, 24(2): 369–384.

  • Kenneth Rogoff (1984), On the Effects of Sterilized Intervention: An Analysis of Weekly Data, Journal of Monetary Economics, 14(1984): 133-150.

  • Liu, P.C. and G.S. Maddala (1992a), Using Survey Data and Tests for Market Efficiency in the Foreign Exchange Market, Empirical Economics, 17(2): 303-314.

  • Lothian, James R., Yusif Simaan (1998), International Financial Relations under the Current Float: Evidence from Panel Data, Open Economies Review, 9(4): 293-313.

  • Malliaropulos, Dimitrios (1997), A Multivariate GARCH Model of Risk Premia in Foreign Exchange Markets, Economic Modelling, 14(1): 61-79.

  • Mc Farland, J.W., P.C. McMahon and Y. Ngama (1994), Forward Exchange Rates and Expectations during the 1920s: A Re-examination of the Evidence, Journal of International Money and Finance, 13(1994): 627-636.

  • McCallum, J. Monet (1994), Uncovered Interest Parity and Policy Behavior: New Evidence, Economic Letter, JEL classification codes: F31; E58, 69(1): 81-87.

  • Meredith Guy, Chinn D. Minjie (1998), Long-Horizon Uncovered Interest Rate Parity, NBER Working Paper, 1998, Working Paper No. W6797.

  • Moosa, A. Imad (1996), An Empirical Investigation into the Causes of Deviations from Covered Interest Parity across the Tasman, New Zealand Economic Papers, 30(1): 39-54.

  • Ozcan Karahan, Olcay Colak (2012), Does Uncovered Interest Rate Parity Hold in Turkey?, International Journal of Economics and Financial Issues, 2(4): 386-394.

  • Poeveridge, S. and C.R Nelson (1981), A New Approach to Decomposition of Economic Time Series into Permanent and Transitory Components with Particular Attention to Measurement of the “Business Cycle”, Journal of Monetary Economics, 7(1981): 152-174.

  • Sikdar S., C.K. Mukhopadhyay (2016), Covered Interest Rate Arbitrage Parity (CIRAP) and ‘Efficiency’ of Foreign Exchange (Rupee/Dollar) Market in India – Time Series Econometric Study with Forward Rates and ARIMA Forecasts, International Journal of Business and Management, 4(5): 284-294, May.


Abstract Views: 484

PDF Views: 0




  • Covered Interest Parity Arbitrage and Long-Run Relation between Spot and Forward Rates in Foreign Exchange (Rupee/Dollar) Market in India-Study of Market Efficiency with Arima (p, d, q) Forecasting

Abstract Views: 484  |  PDF Views: 0

Authors

Suman Sikdar
Department of Economics, KGT Mahavidyalaya, Bagdogra 734014, West Bengal, India
C. K. Mukhopadhyay
Department of Economics, University of North Bengal, Raja Rammohunpur 734014, West Bengal, India

Abstract


The study examines the relation that spot exchange rate maintains with contemporaneous and one – month lagged forward rates in the framework of covered interest parity arbitrage in Indian foreign exchange (rupee/dollar) market from 3rd January, 2011 to 2nd November, 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 MMSE forecasts and ‘Rational’ by nature. The study shows that one – month lagged forward rate maintains an independent long – run stable relation with spot rate while there exists no co-integrating relation between spot rate and contemporaneous forward rate. One – period lagged forward rate is an optimal forecast of the next period spot rate in the sense that it will be proved wrong only to the extent ofa white noise error term. Risk premium is absent and CIRAP holds in the market such that lagged forward exchange rate on average equals the spot rate in the long – run. There exists no scope for reaping arbitrage profit arising out of the difference between forward rate and corresponding spot rate. This testifies for the ‘efficiency’ of Indian foreign exchange (rupee/dollar) market.

References





DOI: https://doi.org/10.21648/arthavij%2F2017%2Fv59%2Fi2%2F164442