Acknowledgements
Alper and Ardic would like to acknowledge financial support by Bogazici University Re-
search Fund 06C102. Alper acknowledges financial support from TUBA-GEBIP (Turkish
Academy of Sciences - Young Scientists Scholarship Program).
Notes
1See Froot and Thaler (1990), Lewis (1995), Taylor (1995), Engel (1996), Sarno (2005), Isard (2006), and
Chinn (2006) for related literature surveys.
2 Throughout the paper, excluding the interest rates, variables in lowercase letters denote the natural
logarithms. In the literature, exchange rates are expressed in natural logarithms to avoid the Siegel’s
paradox: Et [S + k ] = EtS + k . See Edlin (2002) for a detailed discussion on the Siegel’s paradox.
3Essentially, if the CIP condition holds, estimating (3b) implies testing for the UIP condition as well as
the forward rate unbiasedness hypothesis, i.e. ftk = st+k.
4We use deviations from the UIP condition and the forward premium bias interchangeably throughout
Section 2. Yet, for Section 3 where we present the studies that focus on emerging market economies, we
differentiate between using equation (3a) and (3b), as the CIP condition may not hold for emerging market
economies (Kumhof, 2001).
5 The range of potential issues that have implications for deviations from the UIP condition is certainly
non-exhaustive. For instance, departures from the UIP condition may be related with deviations from
the purchasing power parity (PPP) condition (possibly in the long run), as adjustments in capital and
commodity markets towards equilibrium may be interdependent (Juselius, 1995). Hence, the UIP condition
can be tested together with the PPP condition within a cointegration framework, and a joint testing of these
parity conditions may improve the empirical results in the sense the UIP condition may hold only when it is
tested jointly with the PPP (Ozmen and Gokcan, 2004). There are also term structure models in which the
term structure of the forward premium may impart useful information on the spot exchange rate movement
(see, for instance, Clarida and Taylor, 1997; Clarida et al., 2003) or in which the term structure of interest
rates is analyzed together with the UIP condition (inter alia, Bekaert et al., 2007).
6 Another implication of the monetary policy action within the UIP context is the possibly-delayed over-
shooting of the nominal exchange rate in response to a positive interest rate shock. This phenomenon,
conventionally named as delayed overshooting, is supported empirically by Eichenbaum and Evans (1995)
who document for the U.S. for the late 1970s and 1980s that a contractionary monetary policy that leads to
a persistent increase in the domestic interest rate is followed by a currency depreciation only after several
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