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An empirical study of nonlinear adjustment in the UIP model using a smooth transition regression model

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  • Li, Dandan
  • Ghoshray, Atanu
  • Morley, Bruce

Abstract

This study considers the nonlinear relationship between the expected exchange rate change and the interest rate differential, using STR models (ESTR and LSTR), with Sharpe ratios, interest rate differentials and exchange rate volatilities as the transition variables. The results generally conclude that UIP holds with the larger Sharpe ratio and higher exchange rate volatility regimes, which is consistent with the transaction costs and limits to speculation hypotheses. However, the interest rate differential (which is generally not used much as a transition variable) when used in this study results in a failure to support UIP in the upper regime, which suggests it is the risk not the pure return that determines the transition.

Suggested Citation

  • Li, Dandan & Ghoshray, Atanu & Morley, Bruce, 2013. "An empirical study of nonlinear adjustment in the UIP model using a smooth transition regression model," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 109-120.
  • Handle: RePEc:eee:finana:v:30:y:2013:i:c:p:109-120
    DOI: 10.1016/j.irfa.2013.07.012
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Juan Carlos Cuestas & Fabio Filipozzi & Karsten Staehr, 2015. "Uncovered Interest Parity in Central and Eastern Europe: Sample, Expectations and Structural Breaks," Working Papers 2015014, The University of Sheffield, Department of Economics.
    2. repec:bla:reviec:v:25:y:2017:i:4:p:695-710 is not listed on IDEAS
    3. Juan Carlos Cuestas & Fabio Filipozzi & Karsten Staehr, 2017. "Uncovered interest parity in Central and Eastern Europe: Expectations and structural breaks," Review of International Economics, Wiley Blackwell, vol. 25(4), pages 695-710, September.

    More about this item

    Keywords

    Uncovered interest parity; Smooth transition model (STR); Sharpe ratio; Limits to speculation; Carry trade;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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