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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. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  2. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," NBER Working Papers 3153, National Bureau of Economic Research, Inc.
  3. Philip R. Lane & Gian-Maria Milesi-Ferretti, 2001. "Long-Term Capital Movements," IMF Working Papers 01/107, International Monetary Fund.
    • 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.
  4. O'Connell, Paul G. J., 1998. "The overvaluation of purchasing power parity," Journal of International Economics, Elsevier, vol. 44(1), pages 1-19, February.
  5. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, vol. 68(1), pages 79-113, July.
  6. 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.
  7. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272.
  8. 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.).
  9. 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.
  10. Jerry Coakley, Ana-Maria Fuertes, Ron Smith, 2001. "Small sample properties of panel time-series estimators with I(1) errors," Computing in Economics and Finance 2001 191, Society for Computational Economics.
  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. Eiji Fujii & Menzie D. Chinn, 2000. "Fin de Siecle Real Interest Parity," NBER Working Papers 7880, National Bureau of Economic Research, Inc.
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