VoxEU: “The new Fama Puzzle”

That’s a new article at the outstanding web portal VoxEU, coauthored by Matthieu Bussière, Menzie Chinn, Laurent Ferrara, and Jonas Heipertz, and based on this paper:

The ‘Fama puzzle’ is the finding that ex post depreciation and interest differentials are negatively correlated, contrary to what theory suggests. This column re-examines the puzzle for eight advanced country exchange rates against the US dollar, over the period up to February 2016. The rejection of the joint hypothesis of uncovered interest parity and rational expectations still occurs, but with much less frequency. In contrast to earlier findings, the Fama regression coefficient is positive and large in the period after the Global Crisis, but survey-based measures of exchange rate expectations reveal greater evidence in favour of uncovered interest parity.

Under the joint hypothesis of uncovered interest parity (no exchange risk premium) and rational exepctations, the probability limit of the estimated β coefficient should be one, as shown in the gray line. The following chart summarizes the switch in Fama regression coefficients from the pre- and post-crisis periods.

Figure 1: OLS regression coefficient of ex post depreciation on interest differential, at one year horizon, for interest rates over 1999M01-2006M08 period (blue bar), and over 2006M09-2015M02 period (red bar). Gray line at value of unity, consistent with uncovered interest parity and rational expectations.

Using survey data, we find that the switch occurs largely because of the change in the correlation of expectations errors and the interest differentials.

The sample covered in our paper ends in 2016M02 (so the last one-year interest rate used is 2015M02, last three month interest rate is 2015M09). One might wonder whether the results persist into the post-Zero Lower Bound period; for at least the euro-dollar exchange rate, they do, as documented in this post.

For results pertaining to other cross-rates (e.g., euro-pound), see this post.

13 thoughts on “VoxEU: “The new Fama Puzzle”

  1. Moses Herzog

    This is one of those that’s slightly hard for me to get my head around. Isn’t this the question we had decided that it was mostly other countries looking for a “safe haven” for their funds?? And so that drove US bond rates and credit rates down?? Or am I thinking of one of the other questions Menzie had touched on?? I’ll click on the VOX link, but I’m too lazy today to try and chase this one down.

  2. Moses Herzog

    I’d like to take issue with something Paul Krugman said in one of his recent columns:

    “Yes, Larry Summers: whatever you think of his role in the Clinton and Obama administrations, he’s a daring, unconventional thinker when not in office, with a strongly progressive lean.”

    Nope, sorry Pantywaist Krugman, that one does not pass the sniff test. You don’t have a bullying phone conversation with a woman, Brooksley Born, telling her that “you” (Summers), Greenspan, Rubin, and Arthur Levitt are going to shove her down on the playground cement and collectively stomp on her face for wanting to sound the warning bell before a huge percentage of lower and middle income Americans get bitch-slapped and their lives ruined by TBTF bankers and then a short time later go “Magic everybody!!!! I got my ‘progressive’ credentials back!!!”. And Mr Krugman, if you are so politically dumb to buy that, then it’s no wonder you wasted about 5 years of columns cheerleading a failed campaigner with the slogan on all her podium stump speeches “I’m With Me”. It’s also no wonder Democrats never get anything accomplished when you apologize for bastards like Summers, who, had Summers tried the same stunt on you he did to Brooksley Born, you’d STILL be waving your dirty baby diaper in the air, wondering daily in your NYT column why more people hadn’t come to console you.

  3. Not Trampis

    Yes it is an outstanding website. i highlight most articles in my Around the Traps.

    Fascinating article.

    I saw nothing wrong in Summer’s role with Clinton. If only we had quality people that Clinton had now.

    1. Moses Herzog

      @ Not Trampis
      I don’t know how they do it in “Aussie Land”, but here in America we needn’t compare ourselves to the lowest common denominator when looking for a point of reference.

      I think Australia is a great country—just want to make clear the point. I could say Helmut Kohl’s cabinet leadership was better than Hitler’s, but exactly what the hell does that mean??

    1. Moses Herzog

      @ Not Trampis
      Says the idiot who uses Aussie phrases that few here understand, or care to learn. If you’re going to try and talk politics you might learn the major European leaders of the last 25 years, it’s helpful. Although if beating up New Zealand is how Aussies feel good about themselves it’s really not surprising you wouldn’t know a recent leader of the predominant country in Europe.

  4. Moses Herzog

    Does anyone else find it ironic that when Menzie posts topics even indirectly related to politics he gets 90 comments, usually 4–5 commenters bitching about the fact they are “political”, but when Menzie posts more academic related posts the people bitching about the political posts have NOTHING to say??

    It might “behoove” them to pay attention to these type posts (such as the one above) more, as then they wouldn’t make such A-holes of themselves.

    If nothing else (actually many things here, if you’re less lazy than I am this weekend and want to get into the minutia) this post and the linked paper will teach you a lot about “capital flows” both global and domestic. Now it’s probably a safe bet that capital flows (as anything money related in society) just might have a connection to politics and making wise decisions in the political sphere therein. But hey, checking out the xxxx [edited mdc] anchors’ legs on FOX news sure is a hell of a lot more fun, eh??

  5. Not Trampis

    I should add I have also highlighted this article on my modest b log. Winston Churchill would say it is a modest blog with much to be modest about !!

  6. Bob Flood

    MC, I have seen some results suggesting the basic arbitrage relation on CIP broke down in the early part of your sample….so you have a new error previous work has negflected.



      1. Moses Herzog

        I pine for the day Menzie tells me “excellent point”. In fact, if I didn’t lust and love alcohol I’d give one of my kidneys for that. That’s not “fishing” by the way, just emoting.

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