The Interest Rate Parity in Fragile Five Countries: Evidence from Unit Root Tests with Breaks

Abstract

This study analyzes the validity of the uncovered interest rate parity for Brazil, India, Indonesia, South Africa, and Turkey, which are grouped as The Fragile Five countries within the literature. The econometric analysis section of the study benefits from unit root tests, a common method that researchers have started to utilize recently. For this reason, we used Fuller (1979), Augmented Dickey andFuller (1981), Philips and Perron (1988), Kwiatkowski et al. (1992), Perron (1989) unit root test with one break, Zivot and Andrews (1992) unit root test with one break, and Enders and Lee (2012) Fourier-ADF unit root tests. In line with the results of the analysis, we obtained strong evidence regarding the validity of the uncovered interest rate parity for Brazil, Indonesia, and Turkey. Results for India vary according to the structure of the break and where the structural break is taken into consideration. This shows that structural breaks and the economic circumstances of the period that the data set is from should be considered. Although results for South Africa show that interest rate parity is generally valid, results for the Fourier-ADF test, which allows for smooth breaks, offered evidence that the interest rate parity was not valid in these countries.