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.

Irving Fisher, PPP, UIP, exchange rates, inflation, interest rates
Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems (jel E42), Corporate Finance and Governance (jel G3), Business Administration and Business Economics; Marketing; Accounting (jel M)
Erasmus Research Institute of Management
hdl.handle.net/1765/10774
ERIM Report Series Research in Management
ERIM report series research in management Erasmus Research Institute of Management
Erasmus Research Institute of Management

Campbell-Pownall, R.A.J, Koedijk, C.G, Lothian, J.R, & Mahieu, R.J. (2007). Irving Fisher and the UIP Puzzle: Meeting the Expectations a Century Later (No. ERS-2007-088-F&A). ERIM report series research in management Erasmus Research Institute of Management. Erasmus Research Institute of Management. Retrieved from http://hdl.handle.net/1765/10774