Chapter 23

Explaining Deviations from Uncovered Interest Rate Parity

P. Bacchetta

University of Lausanne, Lausanne, Switzerland

Centre for Economic Policy Research (CEPR), London, UK

Introduction

A key relationship in international finance is uncovered interest rate parity (UIP). An approximated version of this relationship is

image (23.1)

where st is the log nominal exchange rate (domestic per foreign currency), ii and it* are domestic and foreign one-period nominal interest rates, and Et is market expectation based ...

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