Irving Fisher and the UIP Puzzle: Meeting the Expectations a Century Later
2007-12-07
Research Paper
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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.
Keywords
Classifications using
Journal of Economic Literature (JEL) Classification System
- G3 : Corporate Finance and Governance
- M : Business Administration and Business Economics; Marketing; Accounting
- E42 : Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems
Automatically Extracted Terms
- exchange
- error
- interest
- fisher
- risk premium
- deviation
- regression
- premium
- change
- interest rates
- exchange rate
- forecast
- result
- period
- currency
- risk premia
- equation
- relation
- exchange rates
- factor
