http://repub.eur.nl/res/aut/13904/ List of Publications en http://repub.eur.nl/static-eur/img/logo.png http://repub.eur.nl http://repub.eur.nl/res/pub/10774/ 2007-12-07T00:00:00Z We review Irving Fisher’s seminal work on UIP and on the closely related equation linking interest rates and inflation. Like Fisher, we find that the failures of UIP are connected to individual episodes in which errors surrounding exchange rate expectations are persistent, but eventually transitory. We find considerable commonality in deviations from UIP and PPP, suggesting that both of these deviations are driven by a common factor. Using a dynamic latent factor model, we find that deviations from UIP are almost entirely due to expectational errors in exchange rates, rather than attributable to the risk premium; a result consistent with those reported by Fisher a century ago. http://repub.eur.nl/res/pub/16938/ 2006-02-01T00:00:00Z Introduction [by way of abstract] Two decades ago exchange-rate economics seemed to be in total shambles. That, however, did not last long. Science proceeds by successive approximations and in the intervening years the foreign exchange market became one of the most heavily researched areas in economics. The first wave of findings to come out of this new research concerned the centuries-old theoretical construct of purchasing power parity, and, relatedly, the behavior of real exchange rates. Here the consensus gradually shifted from the widespread view that PPP had collapsed to the view that it was, in fact, a 'useful empirical first empirical approximation' in the long-run, as Lothian and Taylor (1996) put it. In an introduction to the JIMF conference issue on exchange-rate modeling published in 1998, one of us wrote (Koedijk, 1998)1: 'Ten years of data and estimation techniques later the outlook is less bleak. At least in the medium-run a predictable relationship between exchange rates and economic fundamentals has re-emerged and reintroduced tempered optimism in exchange rate economics.'...