Testing Interest Rate Parity and Rational Expectations for Canada and the United States

Allan Gregory

Canadian Journal of Economics, 1987, vol. 20, issue 2, 289-305

Abstract: The purpose of this paper is to examine the joint hypothesis of interest-rate parity and rational expectations for Canada a nd the United States using monthly data. Two approaches to testing are considere d: (1) the substitution method and (2) testing the cross- equation nonlinear rati onal expectations restrictions from solving the interest-rate parity equation. It is demonstrated that standard application of the substitution method requires the assumption that the interest-rate parity equation holds deterministically. Tests for unit roots in the spot exchange-rate and interest-rate differentials are also investigated.

Date: 1987
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