Working Paper: NBER ID: w30638
Authors: Richard T. Baillie; Francis X. Diebold; George Kapetanios; Kun Ho Kim
Abstract: We suggest a new single-equation test for Uncovered Interest Parity (UIP) based on a dynamic regression approach. The method provides consistent and asymptotically efficient parameter estimates, and is not dependent on assumptions of strict exogeneity. This new approach is asymptotically more efficient than the common approach of using OLS with HAC robust standard errors in the static forward premium regression. The coefficient estimates when spot return changes are regressed on the forward premium are all positive and remarkably stable across currencies. These estimates are considerably larger than those of previous studies, which frequently find negative coefficients. The method also has the advantage of showing dynamic effects of risk premia, or other events that may lead to rejection of UIP or the efficient markets hypothesis.
Keywords: No keywords provided
JEL Codes: C22; F30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| forward premium (G13) | spot returns (Y60) |
| forward premium (G13) | UIP rejection (J65) |
| UIP rejection (J65) | market efficiency understanding (G14) |
| forward premium (G13) | risk premia influence (G11) |