1.2 Deviations from the uncovered interest parity
If the UIP condition holds, the exchange rate that was predicted from the interest rate differential 30 days prior to today would equal to the currently observed exchange rate. If the UIP condition does not hold, there would be deviations (i.e., differences) between the predicted exchange rate and actual realized exchange rate. Present (1) time-series of the predicted and actual realized exchange rates in one figure, and (2) time-series of the deviations between them in another figure. Identify the periods, if any,
where the UIP appears to have been significantly violated.
Since the UIP condition can be represented in different ways, deviations from the uncovered interest
rate parity can be represented in different ways as well. One form of deviation is a difference between
the forecasted and actual exchange rate, as discussed above. Another form is a difference between
percentage change in the exchange rate and interest rate differential. Present a scatter plot where the yaxis is an interest rate differential and the x-axis is percentage change in the exchange rate. Discuss
whether your data points lie on the 45-degree line through the origin.
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