The New Fama Puzzle
We re-examine the Fama (1984) puzzle – the finding that ex post depreciation and interest differentials are negatively correlated, contrary to what theory suggests – for eight advanced country exchange rates against the US dollar, over the period up to June 2019. The rejection of the joint hypothesis of uncovered interest parity (UIP) and rational expectations – sometimes called the unbiasedness hypothesis – still occurs, but with much less frequency. Strikingly, in contrast to earlier findings, the Fama regression coefficient is positive and large in the period after the global financial crisis. However, using survey based measures of exchange rate expectations, we find much greater evidence in favor of UIP. Hence, the main story for the switch in Fama coefficients in the wake of the global financial crisis is mostly – but not entirely – a change in how expectations errors and interest differentials co-move. The durability of this phenomenon depends on the persistence in patterns in expectations errors, and the variability of those errors as well as of interest differentials.
We would like to thank Agnès Bénassy-Quéré, Yin-Wong Cheung, Alexander Chudik, Jeffrey Frankel, Jim Hamilton, Jean Imbs, Ben Johannsen, Joe Joyce, Steve Kamin, Evgenia Passari, Arnaud Mehl, Lucio Sarno, and conference participants at the Banque de France-Sciences Po. “Workshop on Recent Developments in Exchange Rate Economics,” the “Jean Monnet Workshop on Financial Globalization and its Spillovers,” and seminars at the Banque de France, ECB, Brandeis and the University of Adelaide for useful comments. The views expressed do not necessarily reflect those of the Banque de France, the Eurosystem, or the National Bureau of Economic Research.
Menzie D. Chinn
Chinn wrote part of this paper while serving as a consultant to Banque de France.Jonas Heipertz
Part of the research was conducted while I was employed as intern at the Banque de France in the year 2014.