Regime switches in exchange rate volatility and uncovered interest parity

Hibiki Ichiue, Kentaro Koyama

Research output: Contribution to journalArticlepeer-review

27 Citations (Scopus)

Abstract

We use a regime-switching model to examine how exchange rate volatility is related to the failure of uncovered interest parity. Main findings are as follows. First, exchange rate returns are strongly influenced by regime switches in the relationship between the returns and interest rate differentials. Second, low-yielding currencies appreciate less frequently, but once it occurs, their movements are faster than when they depreciate. Third, depreciation of low-yielding currencies and low volatility are mutually dependent on each other. Finally, these three findings are more evident for shorter horizons. The second and third results are consistent with a market participants' view: short-term carry trades in a low-volatility environment and their rapid unwinding substantially influence exchange rates. We consider the effects of funding liquidity to explain these results.

Original languageEnglish
Pages (from-to)1436-1450
Number of pages15
JournalJournal of International Money and Finance
Volume30
Issue number7
DOIs
Publication statusPublished - 2011 Nov
Externally publishedYes

Keywords

  • Bayesian Gibbs sampling
  • Carry trade
  • Forward discount puzzle
  • Markov-switching model
  • Uncovered interest rate parity

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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