Real Interest Rates and Real Exchange Rates: Evidence from Indexed Bonds

Douglas Laxton and Michael Bleany ()
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Michael Bleany: University of Nottingham

No 942, Computing in Economics and Finance 1999 from Society for Computational Economics

Abstract: Uncovered interest parity combined with mean reversion in real exchange rates implies a positive correlation between the real interest rate differential and the level of the real exchange rate. Previous empirical work that has attempted to test for this relationship has found little empirical support. In this paper we show that empirical tests are sensitive to measures of inflationary expectations and the real interest rate. If we employ measures of inflationary expectations and real interest rates from indexed bonds, we find that there is a significant positive correlation between real interest rates and the real exchange rate. We also show that this correlation disappears when we use the types of proxies that previous researchers have relied upon to measure inflationary expectations.

Date: 1999-03-01
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