What is the ‘Uncovered Interest Rate Parity – UIP’
The uncovered interest rate parity (UIP) is a parity condition stating that the difference in interest rates between two countries is equal to the expected change in exchange rates between the countries’ currencies. If this parity does not exist, there is an opportunity to make a risk-free profit using arbitrage techniques.
Explaining ‘Uncovered Interest Rate Parity – UIP’
Assuming foreign exchange equilibrium, interest rate parity implies that the expected return of a domestic asset will equal the expected return of a foreign asset once adjusted for exchange rates. There are two types of interest rate parity: covered interest rate parity and uncovered interest rate parity. When this no-arbitrage condition exists without the use of forward contracts, which are used to hedge foreign currency risk, it is called uncovered interest rate parity.
Uncovered Interest Rate Parity Formula and Example
The formula for uncovered interest rate parity takes into account the following variables:
Uncovered Interest Rate Parity (uip) FAQ
What is uncovered interest rate parity?
What is the main difference between covered and uncovered interest?
How do you calculate uncovered interest parity?
What is the interest parity condition under a fixed exchange rate regime?
Does empirical evidence support covered interest rate parity?
Why does uncovered interest parity not hold?
What is a covered interest rate arbitrage?
- Long-horizon uncovered interest rate parity – www.nber.org [PDF]
- Ambiguity aversion: Implications for the uncovered interest rate parity puzzle – www.aeaweb.org [PDF]
- A reexamination of the uncovered interest rate parity hypothesis – www.sciencedirect.com [PDF]
- The (partial) rehabilitation of interest rate parity in the floating rate era: Longer horizons, alternative expectations, and emerging markets – www.sciencedirect.com [PDF]
- Interest differentials and extreme support for uncovered interest rate parity – www.sciencedirect.com [PDF]
- Uncovered interest parity: The long and the short of it – www.sciencedirect.com [PDF]
- Uncovered interest-rate parity over the past two centuries – www.sciencedirect.com [PDF]
- Monetary policy and the uncovered interest rate parity puzzle – papers.ssrn.com [PDF]
- Exchange rate indeterminacy in portfolio balance, Mundell–Fleming and uncovered interest rate parity models – academic.oup.com [PDF]