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When learning about UIRP i have naturally come across the assumptions under which it may hold. However i am having trouble understanding the role of these assumptions and what the actual consequences would be if they did not hold?

Zero transaction costs, free capital mobility, and risk neutral arbitrageurs. What are the actual roles of each of these assumptions and what would happen if they did not hold?

As far as i can tell if there were transaction costs and capital controls then it may make economic agents biased about where to invest their money, but i am not sure if i am along the right lines. Any help would be great thanks!

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  • $\begingroup$ IRP is a no-arbitrage condition. The first two assumptions mean that its violation is indeed an arbitrage opportunity---e.g. if there is transaction cost, it need not guarantee risk free profit net of transaction cost, etc. $\endgroup$ – Michael May 20 at 20:46

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