Title: On the exchange rate expectations: Does UIP really beat PPP and random walks?

Authors: Abdul Rashid

Addresses: Department of Economics, The University of Sheffield, 9 Mappin Street, Sheffield, S1 4DT, UK

Abstract: In this paper, the purchasing power parity, uncovered interest rate parity and random walk component are nested in a single equation and tested for Pakistan. The autoregressive distributed lag framework is used to recover the underlying parameters of exchange rate expectations formation. The estimates of unit-root tests indicate that all the variables have same order of integration. The long-run estimates show that the interest rate differential is the most significant determinant of exchange rate expectations. Besides, I find that the present stance of the exchange rate has also a critical role to play in exchange rate expectations. These findings are of significance in process of financial reforms and to design an effective exchange rate policy alike.

Keywords: PPP; purchasing power parity; UIP; uncovered interest rate parity; random walks; interactions; exchange rate expectations; convergence; long-run estimates; ARDL; autoregressive distributed lag models; financial reforms; exchange rates; single equations; Pakistan; underlying parameters; unit-root tests; variables integration; interest rate differentials; significant determinants; exchange rate policies; economics; business research.

DOI: 10.1504/IJEBR.2012.046825

International Journal of Economics and Business Research, 2012 Vol.4 No.3, pp.346 - 361

Published online: 25 Nov 2014 *

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