International Journal of Economics, Finance and Management Sciences 2014; 2(6): 356-361 Published online December 27, 2014 (http://www.sciencepublishinggroup.com/j/ijefm) doi: 10.11648/j.ijefm.20140206.18 ISSN: 2326-9553 (Print); ISSN: 2326-9561 (Online) Testing the foreign exchange parity relations: A case analysis of UK Sterling, Japanese yen and Us Dollar Ibrahim Zubairu Department of Accountancy Studies, School of Business, Accra Polytechnic, Accra, Ghana Email address: ibrazubairu@yahoo.com To cite this article: Ibrahim Zubairu. Testing the Foreign Exchange Parity Relations: A Case Analysis of UK Sterling, Japanese Yen and Us Dollar. International Journal of Economics, Finance and Management Sciences. Vol. 2, No. 6, 2014, pp. 356-361. doi: 10.11648/j.ijefm.20140206.18 Abstract: Since the financial globalization has expanded and developed increasingly fast in recent years, the international parity relationships have been extensively studied due to their importance in international trade and investment. This paper investigates purchasing power parity (PPP), interest rate parity (IRP) and unbiased expectation hypothesis by analyzing three main currencies; UK sterling, Japanese Yen and US dollar during 2008 to 2010. Further, forward premium or discount is calculated and interpret in the study with time series data and ordinary least square (OLS) regression methodologies. It was found that, the unbiased expectation hypothesis and international interest parity holds for Japan-US case but does not hold for Japan-UK case. Finally, the purchasing Power Parity (PPP) holds for both two cases, which is varies with most previous literature. Keywords: Purchasing Power Parity (PPP), Interest Rate Parity (IRP), USD, GBP, JYP, Forward Premium or Discount, Unbiased Expectation Hypothesis 1. Introduction As the development of international trade and investment, the relationships among interest rate, exchange rate and inflation rate in various countries have drawn great attention from researchers. More specifically, relative purchasing power parity (PPP), covered interest rate parity (CIP), and unbiased expectation relation are main basic international relationships which are widely investigated by authors. According to relation PPP, the exchange rate between two countries adjusts to offset differences in inflation rates, which requires the exchange rate be proportional to the ratio of two price indices. As international Fisher relation states, the interest rate differential between two countries should equal to the expected inflation differential. Therefore, the expected currency depreciation should be offset by interest rate differential between two nations, which is called CIP. In addition, foreign exchange unbiased expectation hypothesis demonstrates that the forward rate is an unbiased predictor of the expected future spot rate. Some of the previous literatures support the foreign exchange parity relationships whereas some violations have been detected, Lothian and Wu (2005). However, it is also argued that short term puzzles are common while the parity relations hold in the long run. As in major economies all over the world, whether the international parity relations hold in currencies such as the UK sterling, Japanese Yen and US dollar is analysed in this study. In recent time, United Kingdom has experienced a stable growth in economics as inflation rates and unemployment have been in relative low levels. As the official currency, pound sterling is one of the most traded currencies in the market of foreign exchange and the most held reserve currencies in global reserves. The economy of Japan has been in the long run stagnation since the bubble in 1990s. The stock and housing market collapsed and the unemployment rate increased since large quantities of corporations broke down. The Japanese Yen is the official currency of Japan, which is one of the extensively used reserve currencies in the world. Since the global financial downturn in 2008, Japanese Yen has been increasing in value relative to other major currencies. As the largest economy in the world, the United States plays an important role in international trade which is second largest exporter and largest importer. The US dollar is the most widely used in transactions across borders and official currencies for several countries. The United States dollar is also the dominant reserve currency in the world. The aim of this paper is to test the international foreign exchange parity conditions consisting of PPP, interest rate