Exchange Rate and Interest Rate Dynamics in an Equilibrium Framework

This paper examines the time series dynamics of spot and forward exchange rates and Eurocurrency deposit rates for four bilateral relationships vis a vis the U.S. dollar using daily data. The equilibrium implied by covered interest parity provides a theoretical foundation from which to estimate and analyze the dynamic properties of each system of exchange rates and interest rates. The structural statistical model is identified by relying on the implied cointegration vectors and long-run neutrality restrictions.