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The Relationship between Exchange Rates and Interest Rate Differentials: a Wavelet Approach

Author Info

  • Hacker, Scott

    ()

    (Jonkoping International Business School)

  • Kim, Hyunjoo

    (Jonkoping International Business School)

  • Månsson, Kristofer

    (Jonkoping International Business School)

Abstract

This paper uses wavelet analysis to investigate the relationship between the spot exchange rate and the interest rate differential for seven pairs of countries, with a small country, Sweden, included in each of the cases. The key empirical results show that there tends to be a negative relationship between the spot exchange rate (domestic-currency price of foreign currency) and the nominal interest rate differential (approximately the domestic interest rate minus the foreign interest rate) at the shortest time scales, while a positive relationship is shown at the longest time scales. This indicates that among models of exchange rate determination using the asset approach, the sticky-price models are supported in the short-run while in the long-run the flexible-price models appear to better explain the sign of the relationship.

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Paper provided by Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies in its series Working Paper Series in Economics and Institutions of Innovation with number 217.

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Length: 23 pages
Date of creation: 11 Feb 2010
Date of revision:
Handle: RePEc:hhs:cesisp:0217
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Keywords: exchange rates; interest rate differential; uncovered interest parity; monetary approach; small-economy; wavelet analysis;

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Find related papers by JEL classification:
  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • F31 - International Economics - - International Finance - - - Foreign Exchange
  • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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Cited by:

  1. Hacker, R. Scott & Karlsson, Hyunjoo Kim & Månsson, Kristofer, 2014. "An investigation of the causal relations between exchange rates and interest rate differentials using wavelets," International Review of Economics & Finance, Elsevier, vol. 29(C), pages 321-329.
  2. Elena Pelinescu & Delia-Elena Diacona?u, 2015. "The Volatility of Romanian Exchange Rate: A GARCH Approach," Review of Economics & Finance, Better Advances Press, Canada, vol. 5, pages 92-99, November.
  3. Hacker, Scott & Kim, Hyunjoo & Månsson, Kristofer, 2010. "An Investigation of the Causal Relations between Exchange Rates and Interest Rate Differentials Using Wavelets," Working Paper Series in Economics and Institutions of Innovation 215, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
  4. Andrieș, Alin Marius & Ihnatov, Iulian & Tiwari, Aviral Kumar, 2014. "Analyzing time–frequency relationship between interest rate, stock price and exchange rate through continuous wavelet," Economic Modelling, Elsevier, vol. 41(C), pages 227-238.
  5. Niyati Bhanja & Arif Billah Dar & Aviral Kumar Tiwari, 2015. "Exchange Rate and Monetary Fundamentals: Long Run Relationship Revisited," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 62(1), pages 33-54, March.

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