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Irving Fisher and the UIP Puzzle: Meeting the Expectations a Century Later

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Author Info
Campbell-Pownall, R.A.J.
Koedijk, C.G.
Lothian, J.R.
Mahieu, R.J. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)

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Abstract

We review Irving Fisher’s seminal work on UIP and on the closely related equation linking interest rates and inflation. Like Fisher, we find that the failures of UIP are connected to individual episodes in which errors surrounding exchange rate expectations are persistent, but eventually transitory. We find considerable commonality in deviations from UIP and PPP, suggesting that both of these deviations are driven by a common factor. Using a dynamic latent factor model, we find that deviations from UIP are almost entirely due to expectational errors in exchange rates, rather than attributable to the risk premium; a result consistent with those reported by Fisher a century ago.

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File URL: http://hdl.handle.net/1765/10774
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Publisher Info
Paper provided by Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam. in its series Research Paper with number ERS-2007-088-F&A Revision_Date: 2009-07-29.

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Date of creation: 07 Dec 2007
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Handle: RePEc:dgr:eureri:1765010774

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Related research
Keywords: Irving Fisher; UIP; PPP; inflation; interest rates; exchange rates;

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References listed on IDEAS
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