Does the Theory of Uncovered Interest Parity Hold for Nigeria?

Abstract

This study employs the conventional Uncovered Interest Parity (UIP) equation to test the validity of the theory for Nigeria vis-à-vis the United States of America. The study also examine the causality relationship existing between the variables in the UIP model.  The results reveal the invalidity of the UIP theory for Nigerian Naira/ United States dollar exchange rates. We hereby conclude that the existence of abnormal profits from interest arbitrage means that the Uncovered Interest Parity between Nigeria and the U.S.A did not hold in reality at some points in time within the period under review. However, the reasons for the failure of UIP theory for Nigeria might be that the capital mobility between the countries is not perfect, or the risk premium in Nigeria is high as perceived by the potential investors. Country risk, which includes political risk and economic risk remain higher for developing countries including Nigeria, than for the developed countries.

JEL Classification:  E4, E42, E43, F3, F31

Key Words: Uncovered Interest Parity, international finance, foreign exchange market, Interest rate Differential