Panel data models and the uncovered interest parity condition: the role of two-way unobserved components

Herger, Nils (2016). Panel data models and the uncovered interest parity condition: the role of two-way unobserved components. International Journal of Finance & Economics, 21(3), pp. 294-310. John Wiley 10.1002/ijfe.1552

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This paper endeavours to show how the specification of the regression testing the uncovered interest parity (UIP) condition can determine whether or not the hypothesized proportional relationship between international interest rate differences and exchange rate changes is rejected. Across major currencies, various terms to maturity, different data frequencies and the short as well as the long time horizon, single-equation regressions partly reject the UIP condition. However, this ‘UIP puzzle’ tends to disappear when panel data regressions account, for example, for risk premiums by means of two-way nobserved component specifications with random or fixed effects for both currencies and time periods. The closest concurrence with the UIP condition arises when specifying the time-specific component as fixed effect, which provides a way to address the potential bias when unobserved exchange rate risk premiums correlate with interest rates.

Item Type:

Journal Article (Original Article)


03 Faculty of Business, Economics and Social Sciences > Department of Economics

UniBE Contributor:

Herger, Nils


300 Social sciences, sociology & anthropology > 330 Economics




John Wiley




Dino Collalti

Date Deposited:

04 Jul 2017 13:23

Last Modified:

12 Nov 2019 15:39

Publisher DOI:


Additional Information:

JEL Code: F31

Uncontrolled Keywords:

Exchange rates; exchange rate risk premium; panel data; uncovered interest parity condition; uncovered interest parity puzzle




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