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UIRPUncovered Interest Rate Parity
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While there are many doubts on the possibility for the fundamental models to determine the exchange rate in the short term, uncovered interest rate parity starts to hold more often, which means that interest rates could determine the exchange rate better in the future.
The uncovered interest rate parity anomaly and foreign exchange market turnover, International Business & Economics Research Journal 11: 299-306.
Running all three shocks simultaneously shows that almost the entire appreciation of sterling over this period can be explained by uncovered interest rate parity.
5 per cent appreciation experienced between March 2013 and July 2014 can be explained by applying the changes in market expectations of the future path of monetary policy in the UK and its biggest trading partners to a simple uncovered interest rate parity condition within our structural model.
Things are however different when it comes to the uncovered interest rate parity theory, the more important subcomponent as it refers only to spot market values, which have a greater effect on the economy than forward prices, which are nothing more than derivative financial instruments.
According to the standard model, the uncovered interest rate parity can be specified as
According to uncovered interest rate parity hypothesis, the expected profit to forward speculation should be zero.
Do purchasing power parity and uncovered interest rate parity hold in the long-run?
The flexible price monetary model assumes continuous absolute purchasing power parity, uncovered interest rate parity, perfect asset substitution, equilibrium in the goods, labor, and foreign exchange markets.
As can be seen, under the assumption of uncovered interest rate parity, the expected exchange rate is inside the crawling bands during most of the period.
When capital is perfectly mobile equation (7) becomes the familiar uncovered interest rate parity condition.