Interest differentials and extreme support for uncovered interest rate parity |
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| Authors: | William D. Craighead George K. Davis Norman C. Miller |
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| Affiliation: | 1. Department of Economics, Wesleyan University, Middletown CT, United States;2. Department of Economics, Farmer School of Business, Miami University, Oxford OH, United States;1. University of Missouri – St. Louis, Department of Finance, College of Business Administration, United States;2. University of Texas at San Antonio, Department of Finance, College of Business Administration, United States;1. Department of Economics, Eastern Mediterranean University, Famagusta via Mersin 10, Northern Cyprus, Turkey;2. Department of Economics, University of Pretoria, Pretoria 0002, South Africa;3. IPAG Business School, Paris, France;4. Department of Economics, Helmut Schmidt University, Holstenhofweg 85, P.O.B. 700822, 22008 Hamburg, Germany;5. College of Business Administration, University of Nebraska at Omaha, 6708 Pine Street, Omaha, NE 68182, USA;6. School of Business and Economics, Loughborough University, Leicestershire LE11 3TU, UK;1. Department of Economics, National and Kapodistrian University of Athens, 1 Sofokleous Str., 10559 Athens, Greece;2. Department of Economics, University of Ioannina, University Campus, 45110 Ioannina, Greece |
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| Abstract: | This paper addresses two findings from the empirical literature testing uncovered interest parity (UIP): (i) more favorable results when interest differentials (IDs) are large and (ii) instability across samples. Simulations demonstrate that explanations of the results using large IDs based on the hypothesis of a “zone of speculative inactivity” are inconsistent with empirical evidence. Furthermore, it is shown that, if agents forecast IDs based on long-run values, coefficient estimates will be unstable if rates of decay in IDs vary significantly and, for ex post UIP to hold, IDs must decay in absolute value. This is consistent with OECD country data. |
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