A theoretical and empirical investigation on the validity of the uncovered interest parity
In the empirical literature, not much support is found for the uncovered interest parity. Especially with free floating exchange rates, the forward rate is a biased predictor of the future exchange rate. This phenomenon can both be explained by an absence of rational expectations or by risk premia in the foreign exchange market. By means of survey data, this study demonstrates that both aspects are indeed important. On the one hand, survey expectations deviate systematically from future realisations. On the other hand, interest differentials do not fully reflect expected depreciations.
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