Does real interest rate parity really work? Historical evidence from a discrete wavelet perspective

Ghaemi Asl Mahdi (), Canarella Giorgio, Stephen Miller and Tavakkoli Hamid Reza
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Ghaemi Asl Mahdi: Faculty of Economics, Kharazmi University, Tehran, Iran
Canarella Giorgio: Department of Economics, University of Nevada, Las Vegas, USA
Tavakkoli Hamid Reza: Faculty of Economics, Imam Sadiq University, Tehran, Iran

Studies in Nonlinear Dynamics & Econometrics, 2023, vol. 27, issue 4, 485-518

Abstract: We test for real interest rate parity using data from six European countries (France, Germany, Italy, the Netherlands, Spain, and the United Kingdom), Japan, and the United States over a period of more than two centuries. Our contribution is threefold. First, we implement a wavelet-based analysis, which examines both frequency and time information contained in a time series. Second, we employ the United States, the United Kingdom, and Germany as alternative base countries in the wavelet regressions to ascertain the sensitivity of the results to the choice of the base country. Third, we test the real interest rate parity over the entire period (1800–2018) and for several non-contiguous subperiods that hold historical significance and relative importance. Three subperiods link to the three globalization waves (1870–1914, 1944–1971, and 1989–2018), and four subperiods connect to the exchange rate regimes. The wavelet-based results suggest that the validity of the real interest rate parity is scale-dependent. The specific evidence in most cases supports the parity at lower frequencies but not at higher frequencies, which is consistent with the idea that the purchasing power parity and uncovered interest parity, the two main ingredients of the real interest rate parity, are mostly valid in the long run.

Keywords: exchange rate regimes; globalization; MODWT; real interest rate parity (search for similar items in EconPapers)
JEL-codes: C22 E43 G15 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1515/snde-2021-0067

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