TESTING UNCOVERED INTEREST PARITY: A CONTINUOUS‐TIME APPROACH*

Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the degree of overlap is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in uncovered interest parity (UIP) regression tests. We specify a continuous‐time model for exchange rates and forward premia robust to temporal aggregation, unlike existing discrete‐time models. We test the UIP restrictions on the continuous‐time model parameters and propose a novel specification test that compares estimators at different frequencies. Our results based on correctly specified models provide little support for UIP at both short and long horizons.