Irving Fisher and the Uip Puzzle: Meeting the Expectations a Century Later

48 Pages Posted: 29 Jan 2008

See all articles by Rachel A.J. Pownall

Rachel A.J. Pownall

Tilburg University - Department of Finance; Maastricht University - Department of Finance

Kees C. G. Koedijk

Tilburg University - Department of Finance

James R. Lothian

Gabelli School of Business, Fordahm University; National Bureau of Economic Research (NBER)

Ronald Mahieu

Tilburg University - Center for Economic Research, Econometrics and Finance Group; TiasNimbas Business School

Date Written: July 2007, 12

Abstract

We review Irving Fisher’s seminal work on UIP and on the closely related equation linking interest rates and inflation. Like Fisher, we find that the failures of UIP are connected to individual episodes in which errors surrounding exchange rate expectations are persistent, but eventually transitory. We find considerable commonality in deviations from UIP and PPP, suggesting that both of these deviations are driven by a common factor. Using a dynamic latent factor model, we find that deviations from UIP are almost entirely due to expectational errors in exchange rates, rather than attributable to the risk premium; a result consistent with those reported by Fisher a century ago.

Keywords: Irving Fisher, UIP, PPP, inflation, interest rates, exchange rates

JEL Classification: G3, M, E42

Suggested Citation

Pownall, Rachel Ann Jane and Koedijk, Kees G. and Lothian, James R. and Mahieu, Ronald J., Irving Fisher and the Uip Puzzle: Meeting the Expectations a Century Later (July 2007, 12). ERIM Report Series Reference No. ERS-2007-088-F&A. Available at SSRN: https://ssrn.com/abstract=1088213

Rachel Ann Jane Pownall (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

Kees G. Koedijk

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 4663048 (Phone)
+31 13 4662052 (Fax)

James R. Lothian

Gabelli School of Business, Fordahm University ( email )

113 West 60th Street
New York, NY 10023
United States
212-636-6147 (Phone)
212-765-5573 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ronald J. Mahieu

Tilburg University - Center for Economic Research, Econometrics and Finance Group ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2430 (Phone)
+31 13 466 3280 (Fax)

HOME PAGE: http://center.uvt.nl/staff/mahieu/

TiasNimbas Business School ( email )

Warandelaan 2
Tilburg, North-Brabant 5071HS
Netherlands

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