Revisiting Uncovered Interest Rate Parity: Switching between Uip and the Random Walk

22 Pages Posted: 16 Jan 2007

See all articles by Ronald Huisman

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Ronald Mahieu

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

Multiple version iconThere are 2 versions of this paper

Date Written: January 15, 2007

Abstract

In this paper, we examine in which periods uncovered interest rate parity was likely to hold. Empirical research has shown mixed evidence on UIP. The main finding is that it doesn’t hold, although some researchers were not able to reject UIP in periods with large interest differentials or high volatility. In this paper, we introduce a switching regime framework in which we assume that the exchange rate can switch between a UIP regime and a random walk regime. Our empirical results provide evidence that exchange rate movements were consistent with UIP over some periods, but not all. Consistent with the existing literature we also show that in periods with large interest differentials or increased exchange rate volatility, the exchange rate is more likely to follow UIP.

Keywords: Exchange rate dynamics, Uncovered interest rate parity, Markov regime switching

Suggested Citation

Huisman, Ronald and Mahieu, Ronald J., Revisiting Uncovered Interest Rate Parity: Switching between Uip and the Random Walk (January 15, 2007). ERIM Report Series Reference No. ERS-2007-001-F&A. Available at SSRN: https://ssrn.com/abstract=957412

Ronald Huisman (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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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