GEB 3373 Lecture Notes - Lecture 36: Purchasing Power Parity, Arbitrage, Market Price
20 Oct 2016
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Document Summary
Arbitrage of good & purchasing power parity. Ppp theory: prices of tradable goods, when expressed in common currency, will tend to equalize across countries due to exchange rate changes. Professional traders seek to profit small differences in price of forex in different markets. Profit from price differences in two geographically distinct markets. Once such opportunity is potted, it disappears very quickly. The buying and selling of three difference currencies to make a riskless profit. Cross rate: exchange rate between two currencies calculated through use of third currency. When cost of buying currency directly differs from cross rate -> profit opportunity. Market is in equilibrium, ex: no profit opportunities, when direct quote and cross rate for each possible pair of the three currencies are equal. Links together individual forex markets because of cross rates. Difference in r between two countries does not equal forward discount/premium on two currencies. Most important form of arbitrage on forex market.
