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A New Test of the Real Interest Rate Parity Hypothesis: Bounds Approach and Structural Breaks

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  • Bagdatoglou, George
  • Kontonikas, Alexandros

Abstract

We test the real interest rate parity hypothesis using data for the G7 countries over the period 1970-2008. Our contribution is two-fold. First, we utilize the ARDL bounds approach of Pesaran et al. (2001) which allows us to overcome uncertainty about the order of integration of real interest rates. Second, we test for structural breaks in the underlying relationship using the multiple structural breaks test of Bai and Perron (1998, 2003). Our results indicate significant parameter instability and suggest that, despite the advances in economic and financial integration, real interest rate parity has not fully recovered from a breakdown in the 1980s.

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File URL: http://repo.sire.ac.uk/handle/10943/113
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Bibliographic Info

Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2009-23.

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Date of creation: 2009
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Handle: RePEc:edn:sirdps:113

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Keywords: real interest rate parity; bounds test; structural breaks;

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  1. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July.
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  5. Alexakis, Panayotis & Apergis, Nicholas & Xanthakis, Emmanuel, 1997. "Integration of international capital markets: further evidence from EMS and non-EMS membership," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 7(3), pages 277-287, October.
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  8. Arghyrou, Michael G & Gregoriou, Andros & Kontonikas, Alexandros, 2007. "Do real interest rates converge? Evidence from the European Union," Cardiff Economics Working Papers E2007/26, Cardiff University, Cardiff Business School, Economics Section.
  9. Lothian, James R. & Wu, Liuren, 2011. "Uncovered interest-rate parity over the past two centuries," Journal of International Money and Finance, Elsevier, vol. 30(3), pages 448-473, April.
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  15. Pietro Cova & Massimiliano Pisani & Nicoletta Batini & Alessandro Rebucci, 2008. "Productivity and Global Imbalances: The Role of Nontradable Total Factor Productivity in Advanced Economies," IMF Staff Papers, Palgrave Macmillan, vol. 55(2), pages 312-325, June.
  16. BAI, Jushan & PERRON, Pierre, 1998. "Computation and Analysis of Multiple Structural-Change Models," Cahiers de recherche 9807, Universite de Montreal, Departement de sciences economiques.
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  18. Flood, Robert P & Rose, Andrew K, 2001. "Uncovered Interest Parity in Crisis: The Interest Rate Defence in the 1990s," CEPR Discussion Papers 2943, C.E.P.R. Discussion Papers.
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Cited by:
  1. Baharumshah, Ahmad Zubaidi & Soon, Siew-Voon & Hamzah, Nor Aishah, 2013. "Parity reversion in real interest rate in the Asian countries: Further evidence based on local-persistent model," Economic Modelling, Elsevier, vol. 35(C), pages 634-642.

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