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Deviations from uncovered interest parity in Malaysia

  • Soo Khoon Goh
  • Guay Lim
  • Nilss Olekalns

This paper applies the Switching ARCH (SWARCH) model of Hamilton and Susmel (1994) to investigate the dynamics of deviations from Uncovered Interest Parity (UIP) for Malaysia for the sample period 1978-2002. In particular, the deviations (or the risk premium) are modelled as a time series subject to discrete regime shifts between two possible states, “high volatility” and “low volatility”. We find that the SWARCH model provides a better description of the data and implies a much lower degree of volatility persistence than conventional ARCH models. Overall, the SWARCH model provides a clearer picture of how the UIP deviations have evolved over time and how the changes in the volatility of the deviations have coincided with major changes in financial liberalisation in Malaysia. This adds credibility to the hypothesis that the shifts are not statistical artefacts but indeed reflect real economic changes.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603100500404231
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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 16 (2006)
Issue (Month): 10 ()
Pages: 745-759

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Handle: RePEc:taf:apfiec:v:16:y:2006:i:10:p:745-759
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  1. Zivot, Eric & Andrews, Donald W K, 2002. "Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 25-44, January.
  2. Tse Yiu Kuen & Tan Kim Song, 1996. "Interest Parity and Dynamic Capital Mobility: The Experience of Singapore," NBER Chapters, in: Financial Deregulation and Integration in East Asia, NBER-EASE Volume 5, pages 335-357 National Bureau of Economic Research, Inc.
  3. Bekaert, Geert & Harvey, Campbell R. & Lumsdaine, Robin L., 2002. "Dating the integration of world equity markets," Journal of Financial Economics, Elsevier, vol. 65(2), pages 203-247, August.
  4. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333.
  5. Hamid Faruqee, 1991. "Dynamic Capital Mobility in Pacific Basin Developing Countries; Estimation and Policy Implications," IMF Working Papers 91/115, International Monetary Fund.
  6. Fong, Wai Mun & See, Kim Hock, 2002. "A Markov switching model of the conditional volatility of crude oil futures prices," Energy Economics, Elsevier, vol. 24(1), pages 71-95, January.
  7. Goh, S. K. & Alias, M. H. & Olekalns, N., 2003. "New evidence on financial openness in Malaysia," Journal of Asian Economics, Elsevier, vol. 14(2), pages 311-325, April.
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