Covered Interest Arbitrage: A Comparative Study of Industrialized Countries and Selected Developing Countries‪.‬

ABSTRACT It is often said that interest rate parity determines exchange rates between currencies of different countries. If interest rate parity holds then there is no opportunity for covered interest arbitrage. This paper shows that interest rate parity holds for most part between U.S.A. and other industrialized countries, and therefore there is no opportunity for covered interest arbitrage for U.S. investors investing in the industrialized countries. The regression results show that interest rates in industrial countries depend on U.S. interest rates and (forward/Spot) rates. The same relationship is not true for interest rates of emerging markets in Asia. The regression results shows that there is absolutely no relationship between U.S. interest rate, (forward/Spot) rates and interest rates in emerging markets in Asia. Therefore it is concluded that Interest rate parity does not hold between U.S.A and the emerging markets in Asia, this offers an opportunity for covered interest arbitrage for U.S. investors and investors of other industrialized countries investing in the emerging markets in Asia. This covered interest arbitrage is possible because of significant differentials in interest rates between the industrialized countries and the emerging markets in Asia. The study shows that although the currency of most of the emerging Asian market depreciated over the eight year period against the U.S. dollar, however the interest rate differentials between U.S.A. and emerging Asian Markets was large enough to earn a positive excess return in most cases. It can be concluded that a U.S. investor can earn an excess return by investing in the emerging markets of Asia instead of investing in other industrialized countries.