Variation in the Slope Coefficient of the Fama Regression for Testing Uncovered Interest Rate Parity: Evidence from Fixed and Time-varying Coefficient Approaches

Camiel de Koning and Stefan Straetmans
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Camiel de Koning: Erasmus University Rotterdam

No 97-014/2, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We investigate the potential presence of time variation in the coefficients of the ''Fama regression'' for Uncovered InterestRate Parity. We implement coefficient constancy tests, rolling regression techniques, and stochastic coefficient modelsbased on state space modelling. Among six major US bilateral exchange rates we find significant evidence for stochastictime variation.Using the statistical equivalence between stochastically varying coefficients and conditional heteroscedasticity we derivea proxy for time-varying 'risk', and investigate whether it explains the well known "negative bias" or "foreign discount biaspuzzle" in the foreign exchange rate literature. We contrast our identification scheme to the ARCH-in-mean approach forempirically identifying risk premia.

Keywords: Uncovered interest parity; time-varying coefficients; state space modelling (search for similar items in EconPapers)
Date: 1997-01-30
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Citations: View citations in EconPapers (3)

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