Uncertainty and the Uncovered Interest Parity Condition: How Are They Related?

There is a well-established literature that documents the failure of the uncovered interest parity (UIP) condition. While a host of factors have been examined as possible reasons behind this result, the role of uncertainty is not fully understood. In this paper, we examine the extent to which economic uncertainty affects the UIP condition in a sample of fourteen economies over the period 2003:1-2018:12. Using threshold panel regression models and exchange rate survey data, we find evidence that the UIP condition holds during low-uncertainty periods but does not during high-uncertainty periods. This finding is robust to the inclusion of other controls, different proxies of uncertainty, changes in the deposit maturity, and estimation method.