NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Reconsideration of the Uncovered Interest Parity Relationship

Bennett T. McCallum

NBER Working Paper No. 4113 (Also Reprint No. r1895)
Issued in July 1992
NBER Program(s):   ME   IFM

The paper first presents reasons for viewing the uncovered interest-parity (VIP) relationship as more important, in terms of economic analysis, than the unbiasedness of forward rates as predictors of future spot exchange rates. The two hypotheses are closely related, so that test rejections of the latter tend to cast doubt on the former, but are not identical--so unbiasedness rejections are not conclusive for UIP. Next, some representative evidence is presented that pertains to alternative versions of the unbiasedness test. Although s[sub t] = [alpha] + ([beta]f[sub t- 1] + [epsilon, sub t] and s[sub t] - s[sub t-1] =[alpha] + [beta](f[sub t-1] ? s[sub t-1]) + [epsilon, sub t] are equivalent under the null hypothesis of [beta]= 1.0, they represent different classes of alternative hypotheses. Empirically, they give rise to extremely different outcomes, estimates of [beta] being very close to 1. 0 in the former equation but in the vicinity of -3.0 in the latter. In a generalized specification that includes both as special cases, the results strongly favor the second specification--thereby rejecting unbiasedness. Finally, three possible explanations for the [beta] = -3 result are considered and related to the UIP condition. Of these three, the latter two--one involving systematically irrational expectations and the other an additional relationship reflecting monetary policy behavior--are consistent with UIP. The policy-response hypothesis, that monetary authorities manage interest-rate differentials so as to resist rapid changes in exchange rates and in these differentials, is attractive conceptually and is capable of explaining not only the [beta] = -3 finding, but also several other notable features of the data.

download in pdf format
   (1349 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w4113

Published: Journal of Monetary Economics, vol. 33, (1994), pp 105-132 citation courtesy of

 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us