There is no logic behind Covered & Uncovered Interest Rate Parity

Hi guys,

In the real world, we would expect that when a central bank of a particular country raises interest rates, that country’s currency starts to appreciate, much like the US dollar has appreciated ever since the Fed started raising rates since December 2017.

Why then, does the Covered and Uncovered Interest Rate Parity state that the currency with the higher interest rate should trade at a forward discount and a lower expected spot price in the future, (respectively for Covered & Uncovered).


Covered interest rate parity has to hold. And it has nothing to do with future spot prices.

There’s no reason for uncovered interest rate parity to hold.

  1. If covered interest rate parity does not hold, that would give rise to an arbitrage opportunity. So it has to to hold, irrespective of any factor.

  2. Uncovered interest rate parity states that the expected change in spot price is suggested by the levels of interest rate. But in most cases the expected rates are not realized, giving rise to carry trade profits. Bottomline Uncovered interest rate parity need not hold.