Some specification tests of uncovered interest parity

Recent exchange rate theorising has relied increasingly on some version of the uncovered interest parity (UIP) condition. This reliance reflects a belief that the UIP condition isa better building block for an exchange rate model than purchasing power parity, which has demonstrably not held for the recent floating period1. But is UIP a better building block? The empirical evidence on UIP is somewhat mixed - some researchers find in favour of the hypothesis whilst others argue that it is not supported by the data. Clearly the validity of UIP is of considerable interest and importance since a number of celebrated results, such as the Dornbusch (1976) overshooting story, depend on it. In this paper we re-examine the UIP condition for four major currencies using weekly data. Our study has a number of novel features. Thus we conduct specification tests using residuals from the LUS class in addition to the OLS class and implement error orthogonality tests which, in contrast to many of the extant empirical efficiency tests, use a specific selection criterion. We also consider whether or not errors which arise in the market for one currency have an information role in the markets for other currencies, this is assessed through semi strong error orthogonality tests

Some Specification Tests of Uncovered Interest Parity

Exchange rate theory has recently been concerned with versions of the uncovered interest rate parity (UIP) condition, as an alternative to purchasing power parity. The UIP condition is examined, for the U.S. Dollar, the Deutschemark, the Yen, and the Swiss Franc all against the Pound Sterling, using dynamic specification tests based on residual from the LUS and OLS classes, and selected error orthogonality tests. Market errors for one currency may have an information role for other currencies, this also is tested. It is suggested that spot rates are determined by the same underlying process which requires a considerable amount of past information on market errors for efficient spot rate determination. A role for time varying risk premia is suggested.

Stationarity, structural change and specification in a demand system: the case of energy

The impact of structural change, stationarity of the data and economic theory on energy modelling and forecasting, is investigated for Germany and the UK, using two three-equation models which allow for the long- and short-run behaviour of the constituent variables. The models are specified, restricted and estimated to comply with the above conditions and they are then used to generate one step ahead and dynamic forecasts from each of the two models; one with structural change, and the other without. These forecasts and other aspects of the models are then used to choose the specification. In general structural change, stationarity of the data and economic theory are shown to have important implications for model specification and forecasting.