Discrete policy interventions and rational forecast errors in foreign exchange markets: the uncovered interest parity hypothesis revisited
✍ Scribed by Dimitris G. Kirikos
- Publisher
- John Wiley and Sons
- Year
- 2002
- Tongue
- English
- Weight
- 133 KB
- Volume
- 7
- Category
- Article
- ISSN
- 1076-9307
- DOI
- 10.1002/ijfe.195
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✦ Synopsis
Abstract
This paper combines policy response explanations of the uncovered interest parity puzzle with a time series approach that accounts for discrete central bank interventions. When monetary authorities manage the interest rate differential through an anti‐inflationary policy rule, which allows for discrete shifts, then a stochastic segmented trends representation seems appropriate for the exchange rate and the interest rate differential series. In this setting, rational forecast errors are possible, and a test of the uncovered parity hypothesis, based on the cross‐equation restrictions on a Markov switching process, suggests that the parity relationship cannot be rejected for three European currencies vis‐à‐vis the US dollar. Copyright © 2002 John Wiley & Sons, Ltd.