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Testing Uncovered Interest Parity: A Continuous-Time Approach

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  • Enrique Sentana

    ()

  • Antonio Diez de los Rios

    ()
    (CEMFI, Centro de Estudios Monetarios y Financieros)

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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Bibliographic Info

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

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Citations

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Cited by:
  1. Francisco Peñaranda & Enrique Sentana, 2008. "Spanning tests in return and stochastic discount factor mean-variance frontiers: A unifying approach," Economics Working Papers 1101, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2010.
  2. Corrado Macchiarelli, 2013. "On the Joint Test of the Uncovered Interest Parity and the Ex-ante Purchasing Power Parity," Review of International Economics, Wiley Blackwell, vol. 21(3), pages 519-535, 08.
  3. Antonio Diez de los Rios, 2013. "A New Linear Estimator for Gaussian Dynamic Term Structure Models," Working Papers 13-10, Bank of Canada.

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