Working Paper: NBER ID: w18482
Authors: Menzie D. Chinn; Saad Quayyum
Abstract: We review the evidence for both short and long horizon uncovered interest parity (UIP) and rational expectations over the period up to 2011, extending the sample examined in Chinn and Meredith (2004) by nearly a decade. We find that the joint hypothesis of UIP and rational expectations (known as the unbiasedness hypothesis) holds better at long horizons than at short, although the effect is somewhat weaker than documented in Chinn and Meredith (2004). Using the formula for the slope coefficient, we identify potential sources for the difference in slope coefficients at different horizons. We attribute our weaker findings for long horizon unbiasedness for certain currencies partly to the advent of extraordinarily low interest rates associated with the zero interest bound in Japan and Switzerland.
Keywords: Uncovered Interest Parity; Rational Expectations; Exchange Rates; Interest Rates
JEL Codes: F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| UIP holds better at long horizons (D15) | unbiasedness hypothesis holds better (C12) |
| low interest rates in Japan and Switzerland (E43) | attenuate long horizon unbiasedness effect (G40) |
| variations in bond yields (E43) | affect results of UIP (J65) |
| failure of unbiasedness hypothesis (G41) | more pronounced at long horizons with British pound (F31) |
| interest differentials (E43) | unchanged relationship with exchange rate changes at short horizons (F31) |
| changes in interest rate environments and market dynamics (E43) | influence behavior of UIP (J65) |