The Relationship between Exchange Rates and Interest Rate Differentials: A Wavelet Approach

This paper uses wavelet analysis to investigate the relationship between the spot exchange rate and interest rate differential for seven pairs of countries, with a small country, Sweden, included in each case. The key empirical results show that there tends to be a negative relationship between the...

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Bibliographic Details
Published in:World economy 2012-09, Vol.35 (9), p.1162-1185
Main Authors: Scott Hacker, R., Karlsson, Hyunjoo Kim, Månsson, Kristofer
Format: Article
Language:English
Subjects:
Assets
Correlation analysis
Currency in circulation
Economic models
Economics
Exchange market
Exchange Rate
Exchange rate determination
Exchange rates
Foreign exchange rates
Interest Rate
Interest rates
Manycountries
Money
Nationalekonomi
Price models
Prices
Sticky prices
Studies
Sweden
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Summary:This paper uses wavelet analysis to investigate the relationship between the spot exchange rate and interest rate differential for seven pairs of countries, with a small country, Sweden, included in each case. The key empirical results show that there tends to be a negative relationship between the spot exchange rate (domestic‐currency price of foreign currency) and nominal interest rate differential (approximately the domestic interest rate minus the foreign interest rate) at the shortest timescales, while a positive relationship is more frequently found at the longest timescales. This indicates that among models of exchange rate determination using the asset approach, the sticky‐price models are supported in the short run and flexible‐price models in the long run.
ISSN:0378-5920
1467-9701
1467-9701
DOI:10.1111/j.1467-9701.2012.01466.x