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Parity Conditions in International Marke...

Lipson, Marc L.

Technical Note

Parity Conditions in International Markets

Lipson, Marc L.

F-1572 | Published August 19, 2008 | 16 pages Technical Note

Collection: Darden School of Business

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This note reviews the four central parity conditions that underlie most theories regarding the relationship between exchange rates, inflation, and interest rates. The concepts are illustrated through a unified example exploring the relation between the US dollar and the Norwegian krone. The note presents both an intuitive understanding of the relations as well as precise mathematical formulas frequently employed in analysis.

The learning objective is to familiarize students with basic parity conditions and the underlying intuition that drives the relations. While the intuition is the focus of the note and the approximate relations (e.g., simple differences in rates) are shown, the note also provides rigorous development of exact relations that allow sophisticated calculations.