Abstract

Uncovered Interest Parity in the European Monetary System

This study examines the impact of exchange rate coordination on the uncovered interest parity relationship. For this purpose, I tested uncovered interest parity for the EMS currencies: Dutch Guilder, Italian Lira and French Franc and thenon EMS currencies: US Dollar, Pound Sterling and Swiss Franc over the period April 1979 to October 1990. All exchange rates are quoted against the German Mark. To grasp the impact of enhanced exchange rate coordination over time, the sample is split up into two sub-samples. The sub-samples were chosen in such a way that in the first period, exchange rate parity changes in the EMS occurred frequently while in the second period changes were made less frequently and to a lesser extent. The a priori assumption that uncovered interest parity holds better in a coordinated market than in a non coordinated market is not supported by the empirical evidence. While I cannot reject the zero hypothesis of uncovered interest parity for any non- EMS currency, Ihave to reject the zero hypothesis for all three EMS currencies. Splitting the sample and testing only one sub-sample does not change the results. The results of this study suggest that exchange rate coordination has no effect on the uncovered interest parity.