TESTING UNCOVERED INTEREST PARITY IN THE PLN/JPY FOREIGN EXCHANGE MARKET: A MARKOV-SWITCHING APPROACH

• Authors: Czech Katarzyna A.
• Languages of publication: EN

Abstracts

EN

Uncovered Interest Parity argues that a high-interest-rate currency tends to depreciate and a low-interest-rate currency to appreciate. Many researchers find opposite tendency in foreign exchange market. This puzzling feature of foreign exchange market is known as forward premium puzzle. The aim of the paper is to examine how exchange rate volatility influences the relationship between returns and interest rate differentials. Markov switching model is applied. It is shown that in regime of low volatility, in the PLN/JPY market, forward premium anomaly appears. However, during the time of high volatility the UIP holds.

Keywords

EN

foreign exchange market; uncovered interest rate parity; forward premium anomaly; Markov-switching model

• Publisher: Katedra Ekonometrii i Statystyki, Szkoła Główna Gospodarstwa Wiejskiego w Warszawie
• Journal: Metody Ilościowe w Badaniach Ekonomicznych
• Year: 2017
• Volume: 18
• Issue: 1
• Pages: 18-26

Contributors

author

Czech Katarzyna A.

• Faculty of Economic Sciences, Warsaw University of Life Sciences – SGGW, Poland

References

• Alexius A. (2001) Uncovered Interest Parity Revisited. Review of International Economics, 9 (3), 505-517.
• Baillie R. T., Chang S. S. (2011) Carry Trades, Momentum Trading and the Forward Premium Anomaly. Journal of Financial Markets, 14, 441-464.
• Bansal R., Dahlquist M. (2000) The forward premium puzzle: different tales from developed and emerging economies. Journal of International Economics, 51, 115 144.
• Berk J. M., Knot K. H. W. (2001) Testing for long horizon UIP using PPP-based exchange rate expectations. Journal of Banking & Finance, 25, 377-391.
• Brunnermeier M., Nagel S., Pedersen L. (2008) Carry Traders and Currency Crashes. National Bureau of Economic Research Macroeconomics Annual, 23, 313-347.
• Chakraborty A., Evans G. W. (2008) Can perpetual learning explain the forward premium puzzle? Journal of Monetary Economics, 55, 477-490.
• Clarida R., Davis J., Pedersen N. (2009) Currency carry trade regimes: Beyond the Fama regression. Journal of International Money and Finance, 28, 1375-1389.
• Domowitz I., Hakkio C. S. (1985) Conditional Variance and the Risk Premium in the Foreign Exchange Marke. Journal of International Economics, 19, 47-66.
• Fama E. F. (1984) Forward and Spot Exchange Rates. Journal of Monetary Economics, 14, 319-338.
• Flood R. P., Rose A. K. (2002) Uncovered Interest Parity in crisis. International Monetary Fund Staff Papers, 49 (2), 252-266.
• Fong W. M. (2010) A stochastic dominance analysis of yen carry trade. Journal of Banking and Finance, 34, 1237-1246.
• Froot K. A., Frankel J. A. (1989) Forward Discount Bias: Is it an Exchange Risk Premium? The Quarterly Journal of Economics, 104, 139-161.
• Froot K. A., Thaler R. H. (1990) Anomalies: Foreign Exchange. The Journal of Economic Perspectives, 4 (3), 179-192.
• Hamilton J. D. (1989) A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle. Econometrica, 57 (2), 357-384.
• Ichiue H., Koyama K. (2011) Regime switches in exchange rate volatility and uncovered interest parity. Journal of International Money and Finance, 30 (7), 1436-1450.
• Jiang C., Chiang T. C. (2000) Do foreign exchange risk premiums relate to the volatility in the foreign exchange and equity markets? Applied Financial Economics, 10, 95 104.
• Li D., Ghoshray A., Morley B. (2012) Measuring the risk premium in uncovered interest parity using the component GARCH-M model. International Review of Economics and Finance, 24, 167 176.
• Lothian J. R., Wu L. (2011) Uncovered Interest-Rate Parity Over the Past Two Centuries. Journal of International Money and Finance, 30, 448-473.
• Mark N. C., Wu Y. (1998) Rethinking deviations from uncovered interest parity: the role of covariance risk and noise. Economic Journal, 108, 1686-1706.
• McCallum B. T. (1994) A reconsideration of the uncovered interest parity relationship. Journal of Monetary Economics, 33, 105-132.
• Muth J. M. [1961], Rational Expectations and the Theory of Price Movements. Econometrica, 29 (3), 315 135.
• Poghosyan T., Kocenda E., Zemcik P. (2008) Modeling Foreign Exchange Risk Premium in Armenia. Emerging Markets Finance and Trade, 44 (1), 41-61.
• Sarno L., Valente G., Leon H. (2006) Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle. Review of Finance, 10, 443 482.
• Serwa D. (2009) Modele kursu walutowego na rynkach finansowych [in:] Marcinkowska-Lewandowska W. (red.), Rubaszek M., Serwa D., Analiza kursu walutowego. Wydawnictwo C. H. Beck, Warszawa 2009, 130-255.