Testing Purchasing Power Parity and Uncovered Interest Rate Parity in a Multivariate Cointegration Analysis for China and India: 1993: Q1 to 2015: Q1

This paper tests the Purchasing Power Parity (PPP) hypothesis and Uncovered Interest Rate Parity (UIP) hypothesis in a multivariate framework for the sample period 1993: Q1 to 2015: Q1 for China and India. The test result shows cointegration between exchange rate, interest rate and prices of domestic and foreign countries both in case of China and India. Hypothesis of strict PPP and UIP, strict PPP and weak UIP, and symmetric PPP and weak UIP are tested separately of each country. The test results show that first two hypotheses neither hold for China nor hold for India. The third hypothesis hold for China only. This means that relative price movement affect exchange rate in case of China but not necessarily affect exchange rate proportionally. For India, although all hypotheses are rejected, a found cointegration between exchange rate, relative interest rate and prices suggest that domestic and foreign price movement affect the exchange rate but neither symmetrically nor proportionally. This implies that the both interest rate and price differential affect the movement in the exchange rate in long run when we consider the goods and assets market together.