International Financial Management: An Analytical Framework, 2nd Edition by Pearson

INTERNATIONAL PARITY RELATIONSHIP 121

The right-hand side of Eq. 4.1 is the ratio of the changes in the price levels in Country X and

Country Y. To express the equation in terms of inflation, let i

x

and i

y

be the rates of inflation in

Country X and Country Y, respectively.

Now,

pt

p

i

x

x

x

()

(0)

=+1

and

pt

p

i

y

y

y

()

(0)

=+1

By substituting these values in Eq. 4.1, the relative form of PPP can be expressed as

SBA

SBA

i

i

tx

y

()

()

()

()

/

/

0

1

1

=

+

+

t

t

(4. 2)

SBASBA

i

i

t

x

t

y

t

() ()

()

()

//

=×

+

+

0

1

1

Eq. 4. 2 can be stated in terms of percentage change in the exchange rates for one period

(i.e. t = 1):

SS

S

ii

i

t

xy

y

((

(

B/A) B/A)

B/A)

−

=

−

+

0

0

1

As mentioned earlier, the currency of a ...