Uncovered Interest Rate Parity over the Past Two Centuries

Abstract

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.

Panel Data Models and the Uncovered Interest Parity Condition: The Role of Two-Way Unobserved Components

“…Another implication of a broader coverage of currencies is that the current panel of exchange rates only dates back to 1880, since the Japanese Yen and the Swiss Franc did either not exist or were not a sufficiently widely traded currency during most of the 19th century. As in Lothian and Wu (2011), for Sterling and the French Franc, the data go back to around 1800. Table 3 reports the results with the top panel using long-term and the bottom panel short-term interest rate differences as regressors.…”

“…As far as possible, the current panel data analysis employs the same or similar data than in Lothian and Wu (2011) for the US dollar, Sterling and the French Franc, which replaces the Euro from the sample of Section 3.1.. Additional data have been collected for the Japanese Yen and the Swiss Franc; details on the sources can again be found in the appendix. A major difference with Lothian and Wu (2011) is that, to concur with the previous results, the US dollar (instead of Sterling) will serve as international currency with respect to which exchange rates and differences in interest rates are defined. Of course, the choice between Sterling and the Dollar arises against (1930-1999) (1930-1999) (1930-1999) (1930-1999) (1930-1999) (1930-1999) (1930-1999) and fixed effects in columns 5 to 11.…”

“…haul with short-term interest rates (followingLothian and Wu (2011)) table reports estimates of (4) with dependent variable s j;tCm s jt . Coefficient estimation is by ordinary least squares in columns 1 to 4 and by panel data estimators with random…”

Uncovered interest parity in Central and Eastern Europe: Expectations and structural breaks

“…Another explanation is the presence of nonlinear relationships. When the interest rate differentials are large, arbitrage becomes more gainful given the presence of transaction costs and UIP is thus more likely to hold (Froot & Thaler, 1990;Lothian & Wu, 2011). Related to this point, higher inflation and interest rates may also make arbitrage worthwhile and UIP more likely to hold (Alper, Ardic, & Fendoglu, 2009;Bansal & Dahlquist, 2000).…”

“…It follows that rejection of UIP may be the result of this very restrictive assumption. 2 A key study, Lothian and Wu (2011), uses spans of two centuries for France, the United Kingdom and the United States, and finds that the reason UIP fails empirically is the hysteresis in the adjustment of expectations. They argue that the slow adjustment of expectation is due to investors needing time to adjust to new monetary regimes.…”