Testing Uncovered Interest Parity: A Continuous-Time Approach

44 Pages Posted: 5 Jun 2008

See all articles by Antonio Diez de los Rios

Antonio Diez de los Rios

Bank of Canada

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

Abstract

Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rates and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP.

Keywords: Exchange Rates, Forward Premium Puzzle, Hausman Test, Interest Rates, Orstein-Uhlenbeck Process, Temporal Aggregation

JEL Classification: F31, G15

Suggested Citation

Diez de los Rios, Antonio and Sentana, Enrique, Testing Uncovered Interest Parity: A Continuous-Time Approach. CEPR Discussion Paper No. DP6516. Available at SSRN: https://ssrn.com/abstract=1140043

Antonio Diez de los Rios

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada

Enrique Sentana (Contact Author)

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

Financial Markets Group

Houghton Street
London School of Economics & Political Science (LSE)
London WC2A 2AE
United Kingdom
+44 20 7955 7002 (Phone)
+44 20 7852 3580 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
1
Abstract Views
855
PlumX Metrics