Uncovered interest parity and the efficiency of the foreign exchange market: a re-examination of the evidence
Uncovered interest parity and the efficiency of the foreign exchange market: a re-examination of the evidence
In this paper, we find that the traditional approach to testing UIP is misleading because of the significant difference in volatility between the change in the log of the exchange rates and the forward premium, and also because of the presence of conditional heteroskedasticity in the data. This difference has an effect on the estimates of the relevant slope parameter and on the estimates of the uncertainty about the parameter. We show by means of a bootstrap simulation experiment that the econometric rejections of UIP can be spurious and that an alternative methodology is needed to test for foreign exchange markets efficiency. We introduce a set of more direct and economically meaningful profitability-based tests of market efficiency based on UIP. Our results are far more favourable than the existing literature to foreign exchange market efficiency
covered interest parity, efficient market hypothesis, taylor expansions, uncovered interest parity, wild bootstrap
189-204
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Pilbeam, Keith
9a971256-9582-4b70-b6a8-bcafe7982218
April 2011
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Pilbeam, Keith
9a971256-9582-4b70-b6a8-bcafe7982218
Olmo, Jose and Pilbeam, Keith
(2011)
Uncovered interest parity and the efficiency of the foreign exchange market: a re-examination of the evidence.
International Journal of Finance & Economics, 16 (2), .
(doi:10.1002/ijfe.429).
Abstract
In this paper, we find that the traditional approach to testing UIP is misleading because of the significant difference in volatility between the change in the log of the exchange rates and the forward premium, and also because of the presence of conditional heteroskedasticity in the data. This difference has an effect on the estimates of the relevant slope parameter and on the estimates of the uncertainty about the parameter. We show by means of a bootstrap simulation experiment that the econometric rejections of UIP can be spurious and that an alternative methodology is needed to test for foreign exchange markets efficiency. We introduce a set of more direct and economically meaningful profitability-based tests of market efficiency based on UIP. Our results are far more favourable than the existing literature to foreign exchange market efficiency
More information
e-pub ahead of print date: July 2010
Published date: April 2011
Keywords:
covered interest parity, efficient market hypothesis, taylor expansions, uncovered interest parity, wild bootstrap
Organisations:
Economics
Identifiers
Local EPrints ID: 348607
URI: http://eprints.soton.ac.uk/id/eprint/348607
PURE UUID: f3d42c1f-ed88-4901-8f01-30f21e055fc9
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Date deposited: 15 Feb 2013 14:50
Last modified: 15 Mar 2024 03:46
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Author:
Keith Pilbeam
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