Working Paper: CEPR ID: DP6516
Authors: Antonio Diez de los Rios; Enrique Sentana
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; Ornstein-Uhlenbeck process; temporal aggregation
JEL Codes: F31; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| overlapping observations (C30) | unreliable UIP tests (J65) |
| temporal aggregation (C41) | unreliable UIP tests (J65) |
| continuous-time model (C32) | accurate estimation of UIP conditions (C51) |
| interest rate differentials (E43) | exchange rate movements (F31) |
| UIP hypothesis (J65) | rejected for all currency pairs (F31) |