Abstract: As the “Three Direct Links” between China mainland and Taiwan begins successfully and the cross-strait financial supervision memorandum comes into effect, the economic communication between China mainland and Taiwan becomes more and more close. Therefore, it becomes more urgent to realize two way and direct exchange between RMB and new Taiwan dollar. This paper uses two methods, the direct method and the indirect method, to price the exchange rate of RMB and new Taiwan dollar. The direct method is based on the Purchasing Power Parity (PPP) and monetary model. Through the multivariate linear regression, we find the relationship between the exchange rate and currency supply, the output, interest rates of the two regions. Whereas, the indirect method is based on the theory of Interest rate parity. Through making unit root test, co-integration test and Granger causality test of NDF exchange rate, the forward exchange rate and spot exchange rate between RMB and U.S dollar, as well as NDF exchange rate and spot exchange rate between new Taiwan dollar and U.S dollar, we find that there is a close relationship among them. Therefore, we replace NDF exchange for forward exchange in Interest rate parity. Through comparison of the two methods, we find the indirect method is more suitable for the determination of exchange rate between RMB and new Taiwan dollar.

Key words: PPP, interest rate parity, non-deliverable forward, co-integration test, Granger causality test