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Uncovered interest parity tests and exchange rate expectations

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  • Philip Marey

Abstract

We show that in a representative agent model with a constant risk premium, the uncovered interest parity (UIP) test coefficient can be expressed as a function of the variables and parameters of the prevailing exchange rate expectations mechanism. Taking into account the market microstructure, the robustness of this relationship is confirmed by simulations with a multi-agent model containing a time-varying risk premium. Distributed lag expectations are able to explain the often large negative values for UIP-test-coefficients usually found in empirical studies, while bandwagon expectations are able to explain more recent findings of UIP-test-coefficients larger than one. Regressive expectations generate positive values, both smaller and larger than one. Adaptive expectations are able to generate the whole spectrum of empirical values.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 54.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:54

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Keywords: exchange rate expectations; uncovered interest parity; market microstructure;

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Cited by:
  1. Erdemlioglu, Deniz M, 2007. "A new Test of Uncovered Interest Rate Parity: Evidence from Turkey," MPRA Paper 10787, University Library of Munich, Germany.

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