Deviations from Covered Interest Rate Parity

Tests of Covered Interest Rate Parity

ECEN’FLY there has been considerable interest in and investigations of whether the covered interest parity (CIP) holds. At the inicroeconomic level, CIP is important because is it a direct consequence of covered interest arbitrage. Its failure to hold would suggest 1) that markets are inefficient in the sense that traders do not take advantage of known profit opportunities, 2) that legal restri...

Deviations from Uncovered Interest Rate Parity: A Post Keynesian Explanation

Testing Uncovered Interest Rate Parity Using LIBOR

We test Uncovered Interest Parity (UIP) using LIBOR interest rates for a wide range of maturities. In contrast to other markets, LIBOR markets have minimal frictions which could lead to rejecting UIP. Using panel unit root test suggested by Palm, Smeekes, and Urbain (2010) and cointegration techniques by Westerlund (2007), we find that UIP holds for shortterm maturities, when market-specific he...

A Dynamic Trading Strategy Approach to Deviations from Uncovered Interest Parity

Foreign exchange predictability is explored from the standpoint of generating explicit dynamic strategies. These are used to assess the economic significance and economic magnitude of the predictability present in exchange rates. It is found that considering the true out of sample behavior of certain dynamic foreign exchange strategies greatly reduces the magnitude of previously reported puzzle...

Weak Interest Rate Parity and Currency Portfolio Diversification

This paper presents a dynamic model of optimal currency returns with a hidden Markov regime switching process. We postulate a weak form of interest rate parity that the hedged risk premiums on currency investments are identical within each regime across all currencies. Both the in-sample and the out-ofsample data during January 2002 March 2005 strongly support this hypothesis. Observing past as...