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COVERED INTEREST PARITY AND FRICTIONS IN CURRENCY AND MONEY MARKETS: ANALYSIS OF BRITISH POUND AND DOLLAR FOR THE PERIOD 1999-2006

Christopher Warburton

Applied Econometrics and International Development, 2018, vol. 18, issue 1, 55-72

Abstract: This paper investigates the stabilizing effects of monetary policy on currency markets when macroeconomic conditions are relatively stable during the Great Moderation. Quarterly time series data from 1999 to 2006 suggest that monetary policy seems to play a dominant role in the stability of currency markets. Though arbitrage and monetary policy jointly and almost exhaustively explain a large proportion of the variation in forward exchange rates, the findings of the paper generally support the theory that arbitrage activities may not necessarily be robust preconditions for instability in currency markets during periods of moderation; especially when the performance of a specific class of convertible currencies is taken into consideration for a given period of time. The paper concludes that the currency and money markets are highly cointegrated and that monetary policy plays a dominant role in minimizing intertemporal frictions in the currency markets.

Keywords: Arbitrage; Cointegration; Exchange Rates; Forward Premium; Covered Interest Parity; Money Market. (search for similar items in EconPapers)
JEL-codes: E52 F30 F31 G10 G12 G15 (search for similar items in EconPapers)
Date: 2018
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