Monetary Policy and Long-Horizon Uncovered Interest Parity

By M. Chinn, G. Meredith. International Monetary Fund Staff Papers, 2004

378 citations recorded by the source corpus.

Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used short-horizon data, we test UIP using interest rates on longer-maturity bonds for the Group of Seven countries. These long-horizon regressions yield much more support for UIP-all of the coefficients on interest differentials are of the correct sign, and almost all are closer to the UIP value of unity than to zero. We then use a macroeconomic model to explain the differences between the short- and long-horizon results. Regressions run on model-generated data replicate the important regularities in the actual data, including the sharp differences between short- and long-horizon parameters. In the short run, the failure of UIP results from the interaction of stochastic exchange market shocks with endogenous monetary policy reactions. In the long run, in contrast, exchange rate movements are driven by the “fundamental,” leading to a relationship between interest rates and exchange rates that is more consistent with UIP.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/7ae973663b286650e77b98b2671a13cc06a41f34

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Citations in the corpus

Exchange Rate Predictability (2013, neutral): “…2001); estimation biases (Bekaert and Hodrick, 2001); imprecise standard errors (Baillie and Bollerslev, 2000, Rossi, 2007a); and small samples (Chinn and Meredith, 2004, who nd positive evidence in longer samples, and Chen and Tsang, 2011, who pool information from the whole term structure).”
The (partial) rehabilitation of interest rate parity in the floating rate era: Longer horizons, alternative expectations, and emerging markets (2006, methodology): “We assume a lag order of 2 (k 1) following Cochrane (1991). The results confirm the failure of the unbiasedness hypothesis over short horizons, similar to findings obtained in other studies.”
Investor Overconfidence and the Forward Premium Puzzle (2011, neutral): “Thus, a distinctive feature of our model is that it explains evidence that the forward premium regression coeffi cients switch from negative to positive at very long horizons (Chinn and Meredith, 2004).”
Predicting daily exchange rate with singular spectrum analysis (2010, neutral): “…and Ouliaris, 1988; Soofi, 1998), sticky-price monetary model (Frankel, 1979), the Balassa-Samuleson productivity differential model (DeGrgorio and Wolf, 1994), the behavioral equilibrium exchange rate model (Clark and McDonald, 1999), and the interest rate parity model (Chinn and Meredith, 2004).”
Testing Uncovered Interest Parity at Short and Long Horizons During the Post-Bretton Woods Era (2002, neutral): “In a related paper (Chinn and Meredith, 2004), 13 An alternative explanation for these results has been forwarded by Lim and Ogaki (2003), who relies upon exogenously determined segmentation between short and long term bond markets.”
Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive? (2004, positive): “The interest rate parity is included in the forecast comparison exercise mainly because it has recently gathered empirical support at long horizons (Alexius, 2001; Chinn and Meredith, 2004), in contrast to the disappointing results at the shorter horizons .”
What Does the Yield Curve Tell Us about Exchange Rate Predictability? (2013, neutral): “Our results are also consistent with the longer-horizon UIP literature, where, for example, Chinn and Meredith (2004) find that the UIP holds better over horizons of five to ten years.”
A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets (2012, neutral): “As shown in the Table, these violations are less pronounced at long horizons, consistent with the evidence documented in Chinn and Meredith (2004) and Alexius (2001).”
Uncovered Interest Rate Parity and the Term Structure (2002, background): “We find that one reason for Chinn and Meredith’s (2004) claim that UIRP holds better at longer horizons is simply sample choice.”