The LKRlJPY Rate and the UIP

Abstract

AttachedOf the main theories that explore on Interest rates and exchange rates, Uncovered Interest Rate Parity (UJP) states that the interest rate difJerential is an unbiased predictor. of the spot exchange rate changes. The impact on investors is that there would be no short term arbitrage profits. Studies based on the relationship between these two variables are rare fOr developing countries like Sri Lanka. Theretorc in order to bridge that gap identilled through search fOr literature, Autoregressive DistJibuted Lags method was employed here to test the UIP. Monthly data on exchange rates and three month risk Iiee interest rates with regard to the selected major extemal trader, Japan fOr the period tiom 2001-2014 were used for this purpose. The findings reveal that UIP does not hold in the short run but there is evidence for UIP to hold in the long run fOr Sri Lanka.