Uncovered Interest Parity and Financial Market Volatility

Our paper addresses the relationship between exchange rates changes and interest rate differentials in the UIP framework, by taking into account capital market and foreign exchange market volatility. We use eight currencies, of which five are Central and Eastern European and three are developed markets currencies, and their relationship to the US dollar. We use OLS regressions to capture the influence of volatility on UIP testing. We find that UIP is not validated, overall and in times of high volatility, but the direction in the exchange rate change indicated by the interest rate differential follows the UIP framework. The relationship between interest rate differentials and exchange rates changes is weak and taking into account market volatility does not significantly alter our results. Key words: exchange rates, volatility, uncovered interest parity