What UIP tests on extreme samples reveal about the missing variable |
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Authors: | Piet Sercu Martina Vandebroek |
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Institution: | KU Leuven, Graduate School of Business Studies, Naamsestraat 69, B-3000 Leuven, Belgium |
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Abstract: | In their UIP regressions, Huisman et al. (1998. Extreme support for uncovered interest parity, Journal for International Money and Finance 17, 211–228.) focus on extreme forward premia and find much higher coefficients. We show that, for such results, the expectation signal needs to be thicker-tailed than the missing variable. Transaction costs may produce the right sort of bias. It is (i) bounded (i.e. it has no tails at all), (ii) wide (i.e. it may generate betas below 1/2) and (iii) U-distributed, which makes an “extreme” sample quite effective. We derive theoretical and numerical results in the direction of what Huisman et al. observe. We also tighten Fama's moment conditions. |
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Keywords: | JEL classification: F31 G14 G15 |
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