Talk:Interest rate parity/GA1

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Reviewer: TonyTheTiger (talk · contribs) 14:32, 10 September 2012 (UTC)[reply]

WP:LEAD
The sources don't address it as such. Technically speaking, there could exist favorable transaction costs that don't eliminate arbitrage opportunities, so the absence of such costs isn't a necessary assumption for the model. John Shandy` • talk 17:39, 12 September 2012 (UTC)[reply]
Even transaction rebates or subsidies, alter arbitrage relationships. They eliminate indifference between investement alternatives.--TonyTheTiger (T/C/BIO/WP:CHICAGO/WP:FOUR) 16:15, 3 October 2012 (UTC)[reply]
Did you see my 04:08, 16 September 2012 response (just below)? They can eliminate indifference and have been shown to explain some of the observed deviations from parity, but can also result in indifference (by negating the opportunity for, or profitability of, interest arbitrage. Parity can hold in cases where transaction costs are absent, but it can also hold in cases where transaction costs are present. I believe such is the implicit and unspoken reason why economists in the literature have not introduced it as a necessary assumption for the model (and another likely reason is the inevitability of paying transaction costs would make the absence of transaction costs a rather unrealistic assumption, compared to capital mobility and perfect substitutability which are more realistic if not common). Beyond this, I can only emphasize that I've not been able to find any sources to support that absence of transaction costs is an assumption of interest rate parity. John Shandy` • talk 16:58, 3 October 2012 (UTC)[reply]
The empirical evidence section discusses capital controls, of which one type is transaction taxes. It also discusses transaction costs, but transaction costs are generally non-tax-related costs, such as brokerage fees, commissions, trade execution fees, subscriptions to real-time information, etc. Transaction costs can't really be avoided and don't limit capital mobility (despite that they may be prohibitive to an arbitraging strategy), which is why I suspect researchers have not assumed their absence up front. Of course, the empirical evidence section contains the line "Factoring in transaction costs arising from fees and other regulations, arbitrage opportunities are fleeting or nonexistent." - though it may seem confusing, remember that by reducing arbitrage opportunities, such transaction costs would be helping parity hold, so their absence would in that case be detrimental to the model's ability to hold empirically. Transaction costs, among other factors, have been shown to explain some of the observed deviations from interest rate parity, particularly in the 1970s (per the Frenkel & Levich source). But, they don't explain all of such deviations and aren't an absolutely necessary assumption. The model's purpose is to demonstrate the relationship between the interest rate, spot rate, and future spot rate or forward rate and explain how rational investors would be expected to behave. Transaction costs can negate deviations from parity, or can themselves result in such deviations, but to have their absence assumed up front is not particularly useful in either scenario (in the former, parity would hold with their presence; in the latter, parity would hold with their absence). At any rate, the intent of that section is to explain only the two most critical assumptions (capital mobility, so that investors can invest abroad, and perfect substitutability, so that investors will even consider investments abroad). John Shandy` • talk 04:08, 16 September 2012 (UTC)[reply]
      • I think what you are saying is that if rates are adjusted for transactions costs we can show parity when it might seem to be absent.--TonyTheTiger (T/C/BIO/WP:CHICAGO/WP:FOUR) 22:41, 3 October 2012 (UTC)[reply]
Yes, I think that is another way of saying it. Transaction costs have been observed as resulting in actual deviations from parity (allowing for potential arbitrage opportunities), but they have also been observed as making arbitrage opportunities unavailable or unfeasible (in which case deviations from parity are illusory, because parity would hold if you adjusted rates to reflect transaction costs). John Shandy` • talk 05:14, 4 October 2012 (UTC)[reply]
Does the article present both of these points?--TonyTheTiger (T/C/BIO/WP:CHICAGO/WP:FOUR) 05:51, 4 October 2012 (UTC)[reply]
I have edited the empirical evidence paragraph to clarify that when transaction costs exceed deviations from parity, they are prohibitive to arbitrage (implying that they are conducive or at least "not-prohibitive" when they don't exceed deviations). The following sentence notes that transaction costs (among other things) can produce deviations and result in parity imprecision. Hopefully these make it a little more clear. I also added a citation for an existing source. John Shandy` • talk 18:59, 4 October 2012 (UTC)[reply]
  • "The interest rate parity condition implies that the expected return on domestic assets will equal the expected return on foreign currency assets, due to an equilibrium in the foreign exchange market resulting from changes in the exchange rate between two countries." seems a bit verbose. How about "With foreign exchange market equilibrium, the interest rate parity condition implies that the expected return on domestic assets will equal the exchange rate-adjusted expected return on foreign currency assets."--TonyTheTiger (T/C/BIO/WP:CHICAGO/WP:FOUR) 16:01, 14 September 2012 (UTC)[reply]
I have rephrased the sentence as Given foreign exchange market equilibrium, the interest rate parity condition implies that the expected return on domestic assets will equal the exchange rate-adjusted expected return on foreign currency assets.. John Shandy` • talk 04:37, 16 September 2012 (UTC)[reply]
  • The LEAD is suppose to summarize the whole article. Make sure each section is summarized in the LEAD. I don't see the final section summarized here.--TonyTheTiger (T/C/BIO/WP:CHICAGO/WP:FOUR) 16:01, 14 September 2012 (UTC)[reply]
I have expanded the lead to summarize the empirical evidence and RIRP sections. John Shandy` • talk 05:28, 16 September 2012 (UTC)[reply]
The content added seems to be too detailed and lengthy for the LEAD. It is about half as long as the content is is summarizing. Make the 2nd paragraph shorter than the first.--TonyTheTiger (T/C/BIO/WP:CHICAGO/WP:FOUR) 06:09, 16 September 2012 (UTC)[reply]
I have condensed the paragraph, it is considerably less detailed and is shorter than the first paragraph. I also adjusted wikilinks accordingly. John Shandy` • talk 16:30, 16 September 2012 (UTC)[reply]
Uncovered interest rate parity
Modifying the image will take more time (since I changed the text to paths), but I have resized the image to 375px as a compromise. See what you think. I did the same for the CIRP image. John Shandy` • talk 17:30, 12 September 2012 (UTC)[reply]
Good find. I have changed the beginning of the sentence to Risk-neutral investors will be indifferent.... John Shandy` • talk 17:43, 12 September 2012 (UTC)[reply]
  • I would like to ask that a sentence accessible to the layperson, establishing background context, motivation, and notability be added to the first paragraph of the introduction linking to one or both of the interest arbitrage articles and citing a reliable source supporting the importance of this concept, please. —Cupco 01:25, 17 September 2012 (UTC)[reply]
I have added the following sentence inside of the first paragraph: Investors cannot then earn arbitrage profits by borrowing in a country with a lower interest rate, exchanging for foreign currency, and investing in a foreign country with a higher interest rate, due to gains or losses from exchanging back to their domestic currency at maturity. I know it is not everything you have asked for, but I don't quite understand what you mean.
What do you mean by motivation? As for background context, I don't know how else I can provide background context because interest rate parity is just a condition that has been observed in international financial markets that has some implications for investors trying to earn arbitrage profits or hedge against risks when assets are exposed to unanticipated changes in exchange rates, but the article already covers all that. The article explains that parity, and deviations from parity, have certain implications for whether or not investors will be able to lock-in profits with arbitrage trading strategies. As for notability, I'm not sure what you mean. Are you contesting the notability of the topic? It is well-published in journals and textbooks for both economics and finance. I think its importance is self-evident, even for a layperson. I value any feedback that the article falls short in this area, but I guess in order for me to address it I need more details on the specific things that are confusing you or obfuscating the importance of the topic. I don't want to just add patchwork sentences to the lead if I can improve the communication of specific parts of the article. John Shandy` • talk 05:38, 17 September 2012 (UTC)[reply]
By motivation, I was referring to my question from last week on the talk page: Why should anyone want to know what this is? I added "The fact that this condition does not always hold allows the opportunity to earn riskless profits from covered interest arbitrage," and consider this request  Done. Thanks for your patience with my earlier inability to grasp why anyone would care about the topic. —Cupco 06:14, 17 September 2012 (UTC)[reply]
Ah, okay. That added sentence says worlds more about what you were trying to point out to me. I think it is a good addition. I slightly reworded it to emphasize potential opportunities (even when the condition fails to hold, opportunities may not exist). John Shandy` • talk 07:00, 17 September 2012 (UTC)[reply]
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