Chris Van Heerden, Masters and Paul Styger, Ph.D. Economics, North-West University, Hoffman Street, Potchefstroom, 2521, South Africa
The goal of this paper is to determine if there is a relationship between the ZAR/Dollar forward exchange rate premium and the nominal and real interest rate differential. This paper will serve as the first step to determine the direction of causality between the ZAR forward exchange rate premium and the prices of South African dual listed stocks. This paper will follow the strategy of Karajczyk (1985), who stated that the foreign exchange risk premium can be explained by real interest rates. Chiang and Yang (2007:182) also stated that the foreign exchange risk premium reflects the real interest rate and equity premiums between trading countries. Daily forward exchange rate points will be taken, transformed into a rate, and compared to the 1-month JIBAR. If the forward points are greater than the 1-month JIBAR then it indicates that the ZAR will depreciate, thus more dollars will be bought. If the forward points are smaller than the 1-month JIBAR then it indicates that the ZAR will appreciate, thus fewer dollars will be bought. The forward exchange rate will, therefore, be compared to the actual spot exchange rate of that specific date to establish the predictive power of the forward exchange premium. In other words, can the interest rate differential be viewed as a predictor of the exchange rate?