Revisiting Uncovered Interest Rate Parity: Switching Between UIP and the Random Walk
AbstractIn this paper, we examine in which periods uncovered interest rate parity was likely to hold. Empirical research has shown mixed evidence on UIP. The main finding is that it doesnâ€™t hold, although some researchers were not able to reject UIP in periods with large interest differentials or high volatility. In this paper, we introduce a switching regime framework in which we assume that the exchange rate can switch between a UIP regime and a random walk regime. Our empirical results provide evidence that exchange rate movements were consistent with UIP over some periods, but not all. Consistent with the existing literature we also show that in periods with large interest differentials or increased exchange rate volatility, the exchange rate is more likely to follow UIP.
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Bibliographic InfoPaper 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-2007-001-F&A.
Date of creation: 15 Jan 2007
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Exchange rate dynamics; Uncovered interest rate parity; Markov regime switching;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-01-23 (All new papers)
- NEP-IFN-2007-01-23 (International Finance)
- NEP-MON-2007-01-23 (Monetary Economics)
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