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Literature Review
‡ An exchange rate represents current
market price of a currency in terms of
other.
Exchange rate system has a vital role in
reducing the risk of fluctuation in exchange
rate
Several factors affect the increase/decrese
in demand and supply of crrency

ontd..
‡ These factors include Inflation,interest
rate, Political stability, current account
Deficit.(Daniel J.
Ikenson,2010;David,2010)
PPP Theory
‡ Purchasing power parity theory states that
nominal exchange rate between two currencies
and ratio of aggregate price levels between the
two countries must be equal, in other words both
currencies have purchasing power in a foreign
country (Taylor 2004).

ontd..
‡ In law of one price, when there is
difference between prices of same good in
two countries, there will an opportunity of
arbitrage for agents to buy goods at low
price and resell them in the country where
prices are high. If the law of one price
equates prices of a good between two
markets, then it can be concluded that
PPP, describing the equality of market
baskets across countries, should hold

ontd«
‡ PPP seems impossible most of the time,
because inflation rate varies among the
countries due to political conditions,
government concerns Etc.
‡ High inflation rate in any country causes
decline in value of currency and vice
verse(Barro & Robert, 1997)

ontd«
‡ Uncovered Interest rate parity Theory

UIRP showed no proof of working after


1990¶s
A number of empirical studies have
recommended that inflation is more linked
to floating exchange rate.(Alogoskoufis &
Smith, 1991)

ontd..
‡ These result had been questioned by
Burdekin and siklos(1999)
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Time Series Plot of Inflation and Exchange
Rate in Asia
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