US shocks and the uncovered interest rate parity

Mengheng Li and Bowen Fu

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: The literature on uncovered interest rate parity (UIP) shows two empirical puzzles. One is the failure of UIP, and the other is the unstable coefficients in the UIP regression. We propose a time-varying coefficients model with stochastic volatility and US structural shocks (TVC-SVX) to study how US structural shocks affect time-variation in the bilateral UIP relation for twelve countries. An unconditional test and a conditional test for UIP are developed. The former tests if UIP coefficients mean-revert to their theoretical values, whereas the latter tests coefficients at each point in time. Our findings suggest that the failure of UIP results from omitted US factors, in particular US monetary policy, productivity and preference shocks, which are also found to Granger cause local movements of UIP coefficients.

Keywords: Time-varying parameter; Stochastic volatility; Model uncertainty; Exchange rate; Uncovered interest rate parity (search for similar items in EconPapers)
JEL-codes: C11 C32 F31 F37 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2020-10
New Economics Papers: this item is included in nep-cba, nep-ecm, nep-mon and nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2020-87

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