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Continuous-time model of uncovered interest parity with regulated jump-diffusion interest differential

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Abstract:

This study investigates to what extent can an exchange rate model built on uncovered interest parity (UIP) match the empirical features of the exchange rate and the interest differential data. This article presents a continuous-time model of UIP in which the interest differential evolves following regulated jump-diffusion. Simulation experiments show that the model is capable of matching several important features of the data. Inclusion of jumps improves the model to capture persistent dynamics of interest differential and fat-tails in exchange rate returns compared to simple diffusion processes.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840500427809

Affiliations: Department of Economics, Tulane University, New Orleans, LA 70118, USA

Publication date: December 10, 2006

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