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Testing Uncovered Interest Parity: A Continuous-Time Approach

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Author Info
Enrique Sentana ()
Antonio Diez de los Rios () (CEMFI, Centro de Estudios Monetarios y Financieros)

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Abstract

Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rate and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP.

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Paper provided by CEMFI in its series Working Papers with number wp2007_0714.

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Date of creation: Sep 2007
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Handle: RePEc:cmf:wpaper:wp2007_0714

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Related research
Keywords: Exchange rates; forward premium puzzle; Hausman test; interest rates; Orstein-uhlenbeck process; temporal aggregation.;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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