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A New Test forMarket Efficiency and Uncovered Interest Parity

Richard Baillie, Francis Diebold (), George Kapetanios and Kun Ho Kim
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Richard Baillie: Michigan State University and University of London
George Kapetanios: University of London
Kun Ho Kim: Concordia University

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: We suggest a new single-equation test for Uncovered Interest Parity (UIP) based on a dynamic regression approach. The method provides consistent and asymptotically efficient parameter estimates, and is not dependent on assumptions of strict exogeneity. This new approach is asymptotically more efficient than the common approach of using OLS withHAC robust standard errors in the static forward premium regression. The coefficient estimates when spot return changes are regressed on the forward premium are all positive and remarkably stable across currencies. These estimates are considerably larger than those of previous studies, which frequently find negative coefficients. The method also has the advantage of showing dynamic effects of risk premia, or other events that may lead to rejection of UIP or the efficient markets hypothesis.

Keywords: Dynamic regressions; forward premium anomaly; rational expectations; efficient markets; robust standard errors (search for similar items in EconPapers)
JEL-codes: C22 C31 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2022-11-03
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Working Paper: A New Test for Market Efficiency and Uncovered Interest Parity (2022) Downloads
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