Extreme support for uncovered interest parity

120

Uncovered Interest-Rate Parity over the Past Two Centuries AbstractWe study the validity of uncovered interest-rate parity (UIP) by constructing ultra long time series that span two centuries. The forward-premium regressions yield positive slope estimates over the whole sample period and become negative only when the sample is dominated by the period of 1980s. We also find that large interest-rate differentials have significantly stronger forecasting powers for currency movements than small interest-rate differentials. Furthermore, when we regress domestic currency returns on foreign bonds against returns on domestic bonds as an alternative test for UIP, the null hypotheses of zero intercept and unit slope cannot be rejected in most cases. Time-series plots of the two return series reveal that their differences are close to zero on average, although large deviations can occur during some sample periods. A historical account of expected and realized regime changes further illustrates how uncovered interest-rate parity holds over the very long haul but can be deviated from for a long period of time due to slow adjustment of expectations to actual regime changes or to anticipations for extended periods of regime changes or other big events that never materialize.JEL CLASSIFICATION CODES: G12, F31.KEY WORDS: Uncovered interest-rate parity, expectation hypothesis, regime changes, small sample problem, Peso problem, extreme sampling.

“…I t∈L is analogously defined for large interest-rate differential periods. A similar extreme sampling technique has been applied in Huisman, Koedijk, Kool, and Nissen (1998).…”

Section: Extreme Samplingmentioning

confidence: 99%

Uncovered interest-rate parity over the past two centuries

Lothian

2011

120

“…Huisman et al (1998) argue that when the forward discount is large in absolute value, it is a good predictor of subsequent exchange rate movements. Papers by Rose (1996, 2002), Lothian and Wu (2003), Baillie and Kiliç (2006), and Sarno et al (2005) have a similar flavor.…”

Section: The Long Horizonmentioning

confidence: 99%

The (partial) rehabilitation of interest rate parity in the floating rate era: Longer horizons, alternative expectations, and emerging markets

Chinn

2006

222

141

This paper examines several new empirical findings in the study of uncovered interest parity. It reviews recent developments in the study of long-horizon interest parity regressions, the implications of relaxing the rational expectations methodology and the characteristics of results pertaining to the non-G7 currencies, including those in less developed economies. In brief, the evidence against uncovered interest parity in the current floating rate era is not as great as is commonly thought, although it is still true that for the major currencies, the short-term interest differential remains a biased predictor of ex post changes in the exchange rate.

“…We allow exchange rates to exhibit different exposures to this risk premium. Our approach allows us to focus on the dynamics of the risk premium directly, as opposed to the approach of Huisman et al (1998), who tested for uncovered interest parity using a panel data model. The introduction of a common component in our model implies that possible other factors are treated as white noise.…”

Section: Introductionmentioning

confidence: 99%

More evidence on the dollar risk premium in the foreign exchange market

Bams

Walkowiak

Wolff

2004

In this article, we develop and estimate an econometric panel data model to capture the common dynamics in dollar risk premia in various forward foreign exchange rates. The common component in the dollar risk premium is highly significant and embodies a common pattern of positive serial correlation (persistence) for the pound, the yen and the mark. Interestingly, our results indicate that the dynamics of the forward prediction error can be attributed almost exclusively to this dollar-related common component. Our evidence also suggests that the three different foreign currencies' dollar risk premia 'respond' to the common factor to different degrees. #