Uncovered Interest Rate Parity – A Central Concept in International Finance
- By Sam van de Schootbrugge
- 5 min read
The uncovered interest rate parity (UIP) condition is a key concept in international macroeconomics and finance. Famously, it appears not to hold over one- to two-year horizons, creating positive excess returns from investing in international currencies. A new NBER working paper revisits the UIP condition using survey data and documents five novel facts:
The UIP premium co-moves with global risk aversion (VIX) for all currencies.
In emerging economies, the interest rate differential co-moves with the VIX, while expected exchange rate changes co-move with the VIX in advanced economies.
The degree of policy uncertainty can explain the negative co-movement of the UIP premium with the VIX, interest rate differentials and country-specific capital inflows in EMs.
There are no overshooting and predictability reversal puzzles – for any currency – when using survey data instead of realised exchange rates.
The classic Fama puzzle disappears in advanced economies when using survey data, as opposed to ex-post exchange rate data, but remains for EMs.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.