Uncertainty and deviations from uncovered interest rate parity

Adilzhan Ismailov and Barbara Rossi

Journal of International Money and Finance, 2018, vol. 88, issue C, 242-259

Abstract: It is well-known that uncovered interest rate parity does not hold empirically, especially at short horizons. But is it really so? We conjecture that uncovered interest rate parity is more likely to hold in low uncertainty environments, relative to high uncertainty ones, since arbitrage opportunity gains become more uncertain in a highly unpredictable environment, thus blurring the relationship between exchange rates and interest rate differentials. In this paper, we first provide a new exchange rate uncertainty index, that measures how unpredictable exchange rates are relative to their historical past. Then we use the new measure of uncertainty to provide empirical evidence that uncovered interest rate parity does hold in five industrialized countries vis-a’-vis the US dollar at times when uncertainty is not exceptionally high, and breaks down during periods of high uncertainty.

Keywords: Uncertainty; Exchange rates; Forecasting; Uncovered interest rate parity; Interest rates (search for similar items in EconPapers)
JEL-codes: C22 C53 F31 F37 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S026156061730133X
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:88:y:2018:i:c:p:242-259

DOI: 10.1016/j.jimonfin.2017.07.012

Access Statistics for this article

Journal of International Money and Finance is currently edited by J. R. Lothian

More articles in Journal of International Money and Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().