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Testing Uncovered Interest Parity: A Continuous-Time Approach

Author

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  • Antonio Diez de los Rios
  • Enrique Sentana

Abstract

Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rates and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP.

Suggested Citation

  • Antonio Diez de los Rios & Enrique Sentana, 2007. "Testing Uncovered Interest Parity: A Continuous-Time Approach," Staff Working Papers 07-53, Bank of Canada.
    • Handle: RePEc:bca:bocawp:07-53
    DOI: 10.34989/swp-2007-53
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    Cited by:

    1. Corrado Macchiarelli, 2013. "On the Joint Test of the Uncovered Interest Parity and the Ex-ante Purchasing Power Parity," Review of International Economics, Wiley Blackwell, vol. 21(3), pages 519-535, August.
    2. Manuel Arellano & Lars Peter Hansen & Enrique Sentana, 2009. "Underidentification? (Resumen)," Working Papers wp2009_0905, CEMFI.
    3. Antonio Diez de Los Rios, 2015. "A New Linear Estimator for Gaussian Dynamic Term Structure Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 33(2), pages 282-295, April.
    4. Elias, Nikolaos & Smyrnakis, Dimitris & Tzavalis, Elias, 2022. "Predicting future exchange rate changes based on interest rates and holding-period returns differentials net of the forward risk premium effects," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 694-715.
    5. Roberto Serrano, 2009. "On Watson's Non-Forcing Contracts and Renegotiation," Economics Bulletin, AccessEcon, vol. 29(3), pages 2350-2360.
    6. Elias, Nikolaos & Smyrnakis, Dimitris & Tzavalis, Elias, 2024. "The forward premium anomaly and the currency carry trade hypothesis," The Quarterly Review of Economics and Finance, Elsevier, vol. 95(C), pages 203-218.
    7. Joan Llull, 2008. "The Impact of Immigration on Productivity," Working Papers wp2008_0802, CEMFI.
    8. Serrano, Roberto & Vohra, Rajiv, 2010. "Multiplicity of mixed equilibria in mechanisms: A unified approach to exact and approximate implementation," Journal of Mathematical Economics, Elsevier, vol. 46(5), pages 775-785, September.
    9. David Martinez-Miera & Rafael Repullo, 2010. "Does Competition Reduce the Risk of Bank Failure?," The Review of Financial Studies, Society for Financial Studies, vol. 23(10), pages 3638-3664, October.
    10. Peñaranda, Francisco & Sentana, Enrique, 2012. "Spanning tests in return and stochastic discount factor mean–variance frontiers: A unifying approach," Journal of Econometrics, Elsevier, vol. 170(2), pages 303-324.
    11. Wai-Mun Har & Ai-Lian Tan & Chong-Heng Lim & Chai-Thing Tan, 2017. "Does Interest Rate Still Matter in Determining Exchange Rate?," Capital Markets Review, Malaysian Finance Association, vol. 25(1), pages 19-25.
    12. Marcus J. Chambers & J. Roderick McCrorie & Michael A. Thornton, 2018. "Continuous Time Modelling Based on an Exact Discrete Time Representation," Springer Books, in: Kees van Montfort & Johan H. L. Oud & Manuel C. Voelkle (ed.), Continuous Time Modeling in the Behavioral and Related Sciences, chapter 0, pages 317-357, Springer.
    13. Kempa, Bernd & Riedel, Jana, 2013. "Nonlinearities in exchange rate determination in a small open economy: Some evidence for Canada," The North American Journal of Economics and Finance, Elsevier, vol. 24(C), pages 268-278.
    14. Yusuke Kamishiro & Roberto Serrano, 2009. "Equilibrium blocking in large quasilinear economies," Working Papers 2009-12, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales.
    15. Repullo, Rafael & Suarez, Javier, 2008. "The Procyclical Effects of Basel II," CEPR Discussion Papers 6862, C.E.P.R. Discussion Papers.
    16. Max Bruche, 2009. "Bankruptcy Codes, Liquidation Timing, and Debt Valuation," Working Papers wp2009_0902, CEMFI.
    17. Efthymios Argyropoulos & Nikolaos Elias & Dimitris Smyrnakis & Elias Tzavalis, 2021. "Can country-specific interest rate factors explain the forward premium anomaly?," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 45(2), pages 252-269, April.
    18. Thornton, Michael A. & Chambers, Marcus J., 2016. "The exact discretisation of CARMA models with applications in finance," Journal of Empirical Finance, Elsevier, vol. 38(PB), pages 739-761.
    19. Hwang, Taeyoon & Vogelsang, Timothy J., 2024. "Some fixed-b results for regressions with high frequency data over long spans," Journal of Econometrics, Elsevier, vol. 244(2).

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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