question archive What are some reasons why interest rate parity may not hold in spite of the economic forces that should ensure the equilibrium relationship?

What are some reasons why interest rate parity may not hold in spite of the economic forces that should ensure the equilibrium relationship?

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What are some reasons why interest rate parity may not hold in spite of the economic forces that should ensure the equilibrium relationship?

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Following are the reasons for not holding the Interest rate parity:

1. A situation where the anticipated return on domestic products not equal to the exchange rate of the anticipated return on foreign currency assets. In this situation, an investor can opt for an arbitrage opportunity that a signal for not holding the IRP (Interest Rate Parity).

2. Non-availability of capital that means investors is unable to exchange domestic assets for foreign assets due to scarce resources.

3. No perfect substitutability for goods, as, when goods are not available for substitution, particularly, the substitution of domestic goods for foreign goods. Then, there will be no interest rate parity as this theory exists on an assumption of perfect substitutability.