MACROECONOMIC FUNDAMENTALS AND FORWARD EXCHANGE MECHANICS

Despite the covered and uncovered interest rate parity conditions being consistently used throughout academia, it is widely acknowledged that they do not hold and are therefore violated in reality. This paper sets out to both bolster and reinforce two macroeconomic risk-based responses regarding an explanation to this financial anomaly. The first, is proposed by (Falconio, 2016) who not only demonstrates a relationship between monetary policy directives and the violations to the parity conditions, but concludes that expansive monetary shifts are linked to higher average currency returns. The second, is presented by (Della Corte, Riddiough and Sarno, 2012), who collectively draw plausible positive links between a nation’s debt imbalance and the lack of parity in the interest conditions. With regards to strengthening their arguments, this research enquiry constructs a similar regression-based methodology with both additional and alternative variables used to capture the monetary, debt and further economic elements respectfully. The results obtained, are certainly aligned to both academics across all of the developing countries included. For the advanced economies and additional speculative economic variables, no such trend or conclusion could be produced. The interpretation provided to both the results obtained and the financial enigma that is commonly referred to as the forward premium puzzle, is that investors negatively respond to the announcement of monetary and leverage shifts in emerging economies and resultingly become risk adverse. In order to maintain the liquidity in this currency therefore, high levels of interest are required to compensate carry trade investors, hence the interest differential and the subsequent lack of parity