Uncovering Uncovered Interest Parity During the Classical Gold Standard Era, 1888-1905

Abstract

This paper examines the uncovered interest parity hypothesis using the dollar-sterling exchange rate during the gold standard era. This period is interesting because the exchange rate was seasonal, because transactions costs were high, and because occasions when uncovered interest rate speculation did not occur can be identified. The paper shows UIP speculation frequently did not occur, that speculation occurred more in response to expected exchange rate changes than interest rate differentials, and that profitability varied systematically with interest rate differentials. The estimated UIP equations are substantially improved by distinguishing occasions when sterling was borrowed not lent.

Testing the interest-parity condition with Irving Fisher's example of Indian rupee and sterling bonds in the London financial market, 1869–1906

“…A small number of contributions have looked at the connections between exchange and interest rates with nineteenth-century data. The focus has thus been on the core currencies of the international gold standard and the years after 1870, including the dollar-to-sterling exchange rate (Goodhart 1969; Coleman 2012), but also the exchange rate between the pound sterling, the French franc, the German mark, and the Dutch guilder (Herger 2018). Concurring with the just-mentioned finding that the UIP condition works better within established fixed exchange-rate regimes, these papers typically found a positive, although not necessarily perfectly proportional, coincidence between high interest rates and currency depreciations.…”