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A new interpretation of the exchange rate-yield differential nexus

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  • Jerry Coakley

    (Department of Accounting, Finance and Management, University of Essex, UK)

  • Ana-Maria Fuertes

    (Faculty of Finance, Sir John Cass Business School, UK)

  • Andrew Wood

    (Department of Accounting, Finance and Management, University of Essex, UK)

Abstract

Empirical studies have had difficulty in establishing the long-run relationship between real exchange rates and real yield differentials predicted by sticky price exchange rate models. We revisit this issue in a nonstationary panel regression framework. This facilitates estimation of a long-run parameter even when the underlying relation-ship is subject to permanent shocks or the variables do not cointegrate. The slope coefficient estimate from a sample of 23 industrialized countries 1973M1-1998M12 has the correct sign and is statistically significant for both short and long-term yields. These results support fundamentals-based models of exchange rate behaviour while permitting real factors to play a role. Moreover, they indicate that capital markets integration is more advanced than hitherto believed. Copyright © 2004 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 9 (2004)
Issue (Month): 3 ()
Pages: 201-218

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Handle: RePEc:ijf:ijfiec:v:9:y:2004:i:3:p:201-218

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  1. Peter C.B. Phillips & Hyungsik R. Moon, 1999. "Nonstationary Panel Data Analysis: An Overview of Some Recent Developments," Cowles Foundation Discussion Papers 1221, Cowles Foundation for Research in Economics, Yale University.
  2. Philip R. Lane & Gian Milesi-Ferretti, 2001. "Long-Term Capital Movements," NBER Working Papers 8366, National Bureau of Economic Research, Inc.
    • Philip R. Lane & Gian Maria Milesi-Ferretti, 2002. "Long-Term Capital Movements," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 73-136 National Bureau of Economic Research, Inc.
  3. Ron Smith & Ana-Maria Fuertes & Jerry Coakley, 2001. "Small Sample Properties of Panel Time-series Estimators with I(1) Errors," Working Papers wp01-08, Warwick Business School, Finance Group.
  4. Pesaran, M.H. & Smith, R., 1992. "Estimating Long-Run Relationships From Dynamic Heterogeneous Panels," Cambridge Working Papers in Economics 9215, Faculty of Economics, University of Cambridge.
  5. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  6. Maurice Obstfeld & Kenneth Rogoff, 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Working Papers 7777, National Bureau of Economic Research, Inc.
  7. Eiji Fujii & Menzie D. Chinn, 2000. "Fin de Siecle Real Interest Parity," NBER Working Papers 7880, National Bureau of Economic Research, Inc.
  8. Nakagawa, Hironobu, 2002. "Real exchange rates and real interest differentials: implications of nonlinear adjustment in real exchange rates," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 629-649, April.
  9. O'Connell, Paul G. J., 1998. "The overvaluation of purchasing power parity," Journal of International Economics, Elsevier, vol. 44(1), pages 1-19, February.
  10. Hali J. Edison & William R. Melick, 1995. "Alternative approaches to real exchange rates and real interest rates: three up and three down," International Finance Discussion Papers 518, Board of Governors of the Federal Reserve System (U.S.).
  11. Hoffmann, M. & MacDonald, R., 2001. "A real differential view of equilibrium real exchange rate," Discussion Paper Series In Economics And Econometrics 0103, Economics Division, School of Social Sciences, University of Southampton.
  12. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272.
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