Survey of Literature on Covered and Uncovered Interest Parities

f_t -s_t = a+b(i_t -i_t^*)+u_t              (2)

Examples of such studies include Grubel (1966), Branson (1969), Cosandier and
Lang (1981), Fratianni and Wakeman (1982). Furthur confirmation of CIP has been
obtained from survey data. Herring and Marston, 1976 and Levich, 1985 present
evidence from interviews of large bankers that reveal that they use spreads between
forward and spot rates to determine the spreads between domestic and foreign currency
deposit rates they offer. Also that CIP condition was used to determine forward exchange
rates that traders offered to clients. Popper (1993) and Vierira (2003) provide evidence
that CIP more or less holds even at longer maturities (more than one year). Deviations
were found to be linked to out-of-line fiscal policies. Taylor and Branson (2004) is a
study of covered interest parity between US and Russia, which finds large bands around
the equality using the TAR technique, but these bands are not symmetric. The lower
bound is close to zero and the upper bound, which involves borrowing in US dollars and
lending in Rubles to be large, about 1 per cent.

II.2 Uncovered Interest Parity (UIP)

Uncovered Interest Parity has become notorious as a favorite theoretical
abstraction which is resoundingly rejected by data. Part of the reason is that it cannot be
tested directly, and therefore has to be tested in conjunction with rational expectations, as
the unbiasedness hypothesis. Froot and Thaler (1990) in a famous survey, reported an

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