An empirical study of nonlinear adjustment in the UIP model using a smooth transition regression model

Dandan Li, Atanu Ghoshray and Bruce Morley

International Review of Financial Analysis, 2013, vol. 30, issue C, 109-120

Abstract: This study considers the nonlinear relationship between the expected exchange rate change and the interest rate differential, using STR models (ESTR and LSTR), with Sharpe ratios, interest rate differentials and exchange rate volatilities as the transition variables. The results generally conclude that UIP holds with the larger Sharpe ratio and higher exchange rate volatility regimes, which is consistent with the transaction costs and limits to speculation hypotheses. However, the interest rate differential (which is generally not used much as a transition variable) when used in this study results in a failure to support UIP in the upper regime, which suggests it is the risk not the pure return that determines the transition.

Keywords: Uncovered interest parity; Smooth transition model (STR); Sharpe ratio; Limits to speculation; Carry trade (search for similar items in EconPapers)
JEL-codes: F30 F31 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:30:y:2013:i:c:p:109-120

DOI: 10.1016/j.irfa.2013.07.012

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