TY - JOUR
AU - Ito,Takatoshi
TI - Use of (Time-Domain) Vector Autoregressions to Test Uncovered Interest Parity
JF - National Bureau of Economic Research Working Paper Series
VL - No. 1493
PY - 1984
Y2 - November 1984
DO - 10.3386/w1493
UR - http://www.nber.org/papers/w1493
L1 - http://www.nber.org/papers/w1493.pdf
N1 - Author contact info:
Takatoshi Ito
Columbia University
School of International and Public Affairs
International Affairs Building
Room 927, (MC 3333)
420 West 118th Street
New York, NY 10027
Tel: 212-854-6401
Fax: 212-749-1497
E-Mail: ti2164@columbia.edu
AB - In this paper, a vector autoregression model (VAR) is proposed in order to test uncovered interest parity (UIP) in the foreign exchange market. Consider a VAR system of the spot exchange rate (yen/dollar), the domestic (US) interest rate and the foreign (Japanese) interest rate, describing the interdependence of the domestic and international financia lmarkets. Uncovered interest parity is stated as a null hypothesis that the current difference between the two interest rates is equal to the difference between the expected future (log of) exchange rate and the (log of) current spot exchange rate. Note that the VAR system will yield the expected future spot exchange rate as a k-step ahead unconditional prediction. Hence, the null hypothesis is stated as nonlinear cross-equational restrictions for the three-equation VAR system. Then UIP is tested by the Wald test between the unrestricted and restricted systems. A test of UIP with a maintained hypothesis of covered interest parity, becomes a hypothesis test of efficiency without risk premium, that is,the forward exchange rate isthe unbiased predictor of the future spot exchange rate, and information is efficiently used in its prediction. Our results are compared to the efficiency test with a single equation using the Hansen-Hodrick procedure for the same data set.
ER -