International Parity Relations and Economic Shock: Evidence from Swiss Franc Unpegging

Abstract

In this paper, we examine the association between the macroeconomic variables - interest and inflation rate, and the expected spot rate of Swiss franc against Euro around the abandonment of the ceiling on the Swiss franc by the Swiss National Bank (SNB), January 15, 2015, using the two international parity relationships, International Fisher effect (IFE) and Purchase Power Parity (PPP). We use the regression analysis to examine the significance of change in daily interest rates and monthly inflation rates on the change in actual daily spot rates. While our empirical results indicate no significant statistical relationship between the two inputs before unpeg period, our additional analysis examining both the magnitude and directional deviation of the actual spot rate compared to the spot rate for both unpeg and peg period predicted using the two parity relations suggest that spot rates predicted based on the IFE relations, in general, is relatively better in predicting the daily spot rate compared to that of the PPP relations. Although both parity relations are not perfect models for predicting daily exchange rates, they can be used as a framework to guide financiers to gain additional insight regarding the short-term directional trend of the spot rate.