Illustration For The Applicability Of Interest Rate Parity Theory In China

Interest-rate Parity Theory, also named Forward Exchange Theory, is an important theoryabout decision of exchange rate. It describes the relationship among interest rate, spotexchange rate and forward exchange rate of two currencies. From the angel of the fundsfluxion, Interest rate Parity Theory describes the relationship between interest rates andexchange rates, and often is applied to the other exchange rate theory in the analysis, as afundamental tool Western scholars have verified the practicality of the theory, but the interestrate parity theory which set up in different countries come to different conclusions. Ourparticular economic environment also has its interest rate parity theory.The writing of this paper is to review the history of the interest rate parity theory,studying from Keynes ‘static interest-rate parity theory to Einsig’s “theory of the reciprocity”.Then begin to study the modern interest-rate parity theory. This paper selects seven years’data from July in2005to January in2013about one year spot exchange rate of the RMBagainst the U.S. dollar, forward exchange rates, The RMB nominal interest rate (SHIBOR1year), U.S. dollar nominal interest rate (LIBOR1year) to analysis, and it takes regressiontests and analysis on the territory of the RMB forward market exchange differences andspreads, then analyzes the reason why the theory is difficult to achieve, for example, RMBexchange rate against the change of foreign exchange demand is inelastic, national restrictionson the flow of international capital, interest rates control, exchange rate rigidity, all of aboveled to transmission mechanism of Interest rate and exchange rate is not perfect. And the paperverified the influence of NDF on CIP (covered interest parity) through empirical analysis. Andcorrect interest rate parity theory on this base, deduce China’s interest rate parity model,finally, we Put forward policy recommendations to improve the country’s financial market,enhance market efficiency, coordinate interest rate and exchange rate. As promote the capitalaccount liberalization; achieve market-oriented of interest rates; and increase the depth andbreadth of the foreign exchange market. The paper suggests the application of interest rateparity in China will be greatly enhanced with the gradual opening up of foreign exchangecontrols and the continuous deepening of China’s reform of the financial system, and will be a great tool to price and forecast RMB forward exchange market exchange.