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Monetary policy and long horizon uncovered interest parity
 IMF Staff Papers
, 2004
"... Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used shorthorizon data, we test UIP using interest rates on longermaturity bonds for the Group of Seven countries. These longhorizon regressions y ..."
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Cited by 58 (9 self)
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Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used shorthorizon data, we test UIP using interest rates on longermaturity bonds for the Group of Seven countries. These longhorizon regressions yield much more support for UIP—all of the coefficients on interest differentials are of the correct sign, and almost all are closer to the UIP value of unity than to zero. We then use a macroeconomic model to explain the differences between the short and longhorizon results. Regressions run on modelgenerated data replicate the important regularities in the actual data, including the sharp differences between short and longhorizon parameters. In the short run, the failure of UIP results from the interaction of stochastic exchange market shocks with endogenous monetary policy reactions. In the long run, in contrast, exchange rate movements are driven by the “fundamental, ” leading to a relationship between interest rates and exchange rates that is more consistent with UIP. [JEL F21, F31, F41] Few propositions are more widely accepted in international economics than that uncovered interest parity (UIP) is at best useless—or at worst perverse—
TimeVarying Risk, Interest Rates, and Exchange Rates in General Equilibrium
, 2005
"... Timevarying risk is the primary force driving nominal interest rate differentials on currencydenominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk vari ..."
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Cited by 57 (6 self)
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Timevarying risk is the primary force driving nominal interest rate differentials on currencydenominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk variation–a variable degree of asset market segmentation–can produce key features of actual interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit ofassetmarketparticipation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. Our model produces variation in the risk premium even though the fundamental shocks have constant conditional variances.
Testing Uncovered Interest Parity at Short and Long Horizons during the Post‐Bretton Woods Era,” NBER Working Paper No
, 2005
"... The hypothesis that interest rate differentials are unbiased predictors of future exchange rate movements has been almost universally rejected in empirical studies. In contrast to previous studies, which have used shorthorizon data, we test this hypothesis using interest rates on ..."
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Cited by 51 (2 self)
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The hypothesis that interest rate differentials are unbiased predictors of future exchange rate movements has been almost universally rejected in empirical studies. In contrast to previous studies, which have used shorthorizon data, we test this hypothesis using interest rates on
ESTIMATING RISK PREMIA IN MONEY MARKET RATES
, 2003
"... This paper empirically tests the expectations hypothesis on both daily EONIA swap rates and monthly EURIBOR rates extended backwards with German LIBOR rates. In addition, we quantify the size of the risk premia in the money market at maturities of one, three, six and nine months. Using implied forwa ..."
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Cited by 46 (0 self)
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This paper empirically tests the expectations hypothesis on both daily EONIA swap rates and monthly EURIBOR rates extended backwards with German LIBOR rates. In addition, we quantify the size of the risk premia in the money market at maturities of one, three, six and nine months. Using implied forward and spot rates in a cointegrated VAR model, we find that the data support the expectations hypothesis in the euro area and in Germany prior to 1999. We find that risk premia are relatively limited at the shorter maturities but more significant at maturities of six and nine months. Furthermore, the results on LIBOR/EURIBOR rates tentatively indicate a downward shift in the structure of the risk premia after the introduction of the euro.
Financial Markets and the Real Economy
, 2006
"... I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” ..."
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Cited by 44 (4 self)
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I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” I survey the literature, covering the timeseries and crosssectional facts, the equity premium, consumptionbased models, general equilibrium models, and labor income/idiosyncratic risk approaches.
Uncovered interest parity: it works, but not for long
 Asset Pricing
, 1996
"... NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other than an acknowledgment that the writer has had access to unpublished material) should be clear ..."
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Cited by 40 (0 self)
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NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other than an acknowledgment that the writer has had access to unpublished material) should be cleared with the author or authors. Recent IFDPs are available on the Web at www.federalreserve.gov/pubs/ifdp/.Uncovered Interest Parity: It Works, But Not For Long
Expectations Hypotheses Tests
 Journal of Finance
, 2001
"... We investigate the Expectations Hypotheses of the term structure of interest rates and of the foreign exchange market using vector autoregressive methods for the U.S. dollar, Deutsche mark, andBritishpoundinterestratesandexchangerates. InadditiontostandardWaldtests,we formulate Lagrange Multiplier a ..."
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Cited by 39 (3 self)
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We investigate the Expectations Hypotheses of the term structure of interest rates and of the foreign exchange market using vector autoregressive methods for the U.S. dollar, Deutsche mark, andBritishpoundinterestratesandexchangerates. InadditiontostandardWaldtests,we formulate Lagrange Multiplier and Distance Metric tests which require estimation under the nonlinear constraints of the null hypotheses. Estimation under the null is achieved by iterating on approximate solutions that require only matrix inversions. We use a biascorrected, constrained vector autoregression as a data generating process and construct extensive Monte Carlo simulations of the various test statistics under the null hypotheses. Wald tests suffer from severe size distortions and use of the asymptotic critical values results in gross overrejection of the null. The Lagrange Multiplier tests slightly underreject the null, and the Distance Metric tests overreject. Use of the small sample distributions of the different tests leads to a common interpretation of the validity of the Expectations Hypotheses. The evidence against the Expectations Hypotheses for these interest rates and exchange rates is much less strong than under asymptotic inference. 2 According to the Expectations Hypothesis, information in current interest rates provides the
Understanding the Forward Premium Puzzle: A Microstructure Approach," NBER Working Paper No.13278
, 2007
"... Highinterestrate currencies tend to appreciate relative to lowinterestrate currencies. We argue that adverseselection problems between participants in foreign exchange markets can account for this ‘forward premium puzzle. ’ The key feature of our model is that the adverse selection problem fac ..."
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Cited by 38 (2 self)
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Highinterestrate currencies tend to appreciate relative to lowinterestrate currencies. We argue that adverseselection problems between participants in foreign exchange markets can account for this ‘forward premium puzzle. ’ The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate. J.E.L. Classification: F31
Taylor Rules and the DeutschmarkDollar Real Exchange Rate
 Journal of Money, Credit and Banking
, 2005
"... We explore the link between an interest rate rule for monetary policy and the behavior of the real exchange rate. The interest rate rule, in conjunction with some standard assumptions, implies that the deviation of the real exchange rate from its steady state depends on the present value of inflatio ..."
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Cited by 36 (1 self)
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We explore the link between an interest rate rule for monetary policy and the behavior of the real exchange rate. The interest rate rule, in conjunction with some standard assumptions, implies that the deviation of the real exchange rate from its steady state depends on the present value of inflation and output gap differentials. An initial look at German data yields some support for the model. We thank the National Science Foundation for financial support, Jeffrey Frankel, Roberto Perotti, Hélène Rey, three anonymous referees and participants in the June 2002 ISOM conference for helpful