Regime Switches in Exchange Rate Volatility and Uncovered Interest Parity

Hibiki Ichiue () and Kentaro Koyama
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Kentaro Koyama: Bank of Japan

No 07-E-22, Bank of Japan Working Paper Series from Bank of Japan

Abstract: We use a regime-switching model to examine how exchange rate volatilities influence the failure of uncovered interest parity (UIP). Main findings are as follows. First, exchange rate returns are significantly influenced by regime switches in the relationship between the returns and interest rate differentials. Second, appreciation of low-yielding currencies occurs less frequently but is faster than the depreciation. Third, low volatilities and UIP failure are mutually dependent. Finally, these findings are more evident for three-month maturity than six-month maturity. These results are consistent with market participants' views: the short-term carry trade in a low-volatility environment and its rapid unwinding substantially influence exchange rates.

Keywords: Uncovered interest rate parity; Forward discount puzzle; Carry trade; Markov-switching model; Bayesian Gibbs sampling (search for similar items in EconPapers)
Date: 2007-11
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Citations: View citations in EconPapers (11)

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Related works:
Journal Article: Regime switches in exchange rate volatility and uncovered interest parity (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:boj:bojwps:07-e-22

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