The international Fisher effect is identified as part of the four-way equivalence model.
This model outlines a relationship between exchange rates, interest rates and inflation
rates. The international Fisher effect, specifically, states that the difference in interest
rates between two countries is an indicator of the expected change in exchange rates of
their currencies.
The aim of this paper is to test the validity of the international Fisher effect between
South Africa and the UK. The understanding of the exchange rate movements is vital for
management decisions, investment activity and policy making for central banks and
government.
Data has been collected for a sampling period beginning in July 1995 and ending in April
2001. Interest rates in the UK and South Africa are recorded for this period. A record of
exchange rate movements for the same period has also been compiled. Using this data, a
simulation of an uncovered interest arbitrage was carried out. This was done by taking
£100 from the UK, converting it to Rands and investing those Rands in a South African
bank. At the same time, £100 was also invested in a UK bank. As interest accrued over
the test period, interest rates in both countries changed, exchange rates fluctuated and the
balance in the South African account was compared to the balance in the UK account.
According to the model, the real balances in both the accounts should remain equivalent
over the sampling period.
It was found that interest rates in SA were higher, more volatile and less cyclic than those
in the UK. As predicted by the model, the exchange rate (in R/£) constantly increased
over the sampling period. Reasons for the higher interest rates in SA include a low
national savings rate, high inflation, the South African economies vulnerability to events
in the international market and the reserve bank's monetary policies.
The simulated arbitrage was found to be profitless and the balances of the two simulated
investment accounts were found to be statistically similar. There were, however, some
short term deviations from the theory. The value of the SA account was lowest during
times of high interest rates in SA, when there was volatility in the forex market and when
the exchange rate was at peaks in the cycle. Nevertheless, the exchange rate - interest rate
relationship always returned to equilibrium.
The risk and unpredictability associated with the international market is high while only
small chances exist to achieve economic gain from borrowing from low interest rate
environments (or investing in countries where the interest rates are high). It was
concluded that the international Fisher effect, between the UK and South Africa, for the
period studied, had significant short term deviations but is valid over the medium term.
The implication for business practice is that stakeholders should be conservative when
faced with risk associated with foreign exchange exposure unless, as is the case with
speculators, it is their core competence to predict macroeconomic trends and profit from
beating the market. / Thesis (MBA)-University of Natal, Durban, 2001.
| Identifer | oai:union.ndltd.org:netd.ac.za/oai:union.ndltd.org:ukzn/oai:http://researchspace.ukzn.ac.za:10413/3831 |
| Date | January 2001 |
| Creators | Singh, S. H. |
| Contributors | Kohler, Marcel. |
| Source Sets | South African National ETD Portal |
| Language | English |
| Detected Language | English |
| Type | Thesis |
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