Variation in the Slope Coefficient of the Fama Regression for Testing Uncovered Interest Rate Parity: Evidence from Fixed and Time-varying Coefficient Approaches
AbstractWe investigate the potential presence of time variation in the coefficients of the ''Fama regression'' for Uncovered InterestRate Parity. We implement coefficient constancy tests, rolling regression techniques, and stochastic coefficient modelsbased on state space modelling. Among six major US bilateral exchange rates we find significant evidence for stochastictime variation.Using the statistical equivalence between stochastically varying coefficients and conditional heteroscedasticity we derivea proxy for time-varying 'risk', and investigate whether it explains the well known "negative bias" or "foreign discount biaspuzzle" in the foreign exchange rate literature. We contrast our identification scheme to the ARCH-in-mean approach forempirically identifying risk premia.
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 97-014/2.
Date of creation: 30 Jan 1997
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Uncovered interest parity; time-varying coefficients; state space modelling;
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