Abnormal profitability and foreign investment based on the investigation of covered interest parity

Most literature focuses on how foreign investment and the market returns are related. Instead, this study attempts to identify the origin of abnormal behavior by foreign investors, as well as the relationship among the error in covered interest parity (ECIP), foreign investment (INV), and stock returns (RS). This study finds that the behavior of ECIP can be accurately represented by the ARJI model, which is capable of describing sudden jumps in the economy. Consequently, CBP-ARJI thus provides an effective means of studying the interaction among underlying variables. Empirically, ECIP has a negative statistical significant influence on foreign investment. While RS and INV have no mutual volatility spillover effect, they have a close correlation in terms of jump intensity. The previous jump of INV had more impact on current INV, while RS had little impact. The early withdrawal of foreign investment causes stock indexes to fall, creating potential losses for general investors. Foreign investment thus observes abnormal ECIP behavior, while leading the market movements, are always better off.