Uncovered interest rate parity: A gravity-panel approach

Abstract

This paper investigates the validity of uncovered interest rate parity (UIRP) which establishes a proportional relationship between interest rate and expected nominal exchange rate differentials. This paper takes a different perspective by using a gravity panel as the methodological approach and modeling the interest rate differential as a function of the expected nominal exchange rate change. Thus, we use all possible nominal exchange rates in our sample to study the validity of the UIRP. We provide evidence in favor of UIRP which holds for a sample of high-income economies; however, this hypothesis is rejected for medium-income countries.

Keywords

• UIRP
• Gravity panel
• Long-term interest rate
• Nominal exchange rate