Depreciation expectations and interest rate differentials: Are there shifting regimes? The case of Peru

This article examines the validity of the Uncovered Interest Rate Parity (UIRP) in the context of the Peruvian financial system, particularly in light of the recent widening of the interest rate spread in favor of the dollar. The research focuses on determining whether this spread can predict exchange rate depreciation, using a sample of monthly data from January 1992 through September 2005. Various econometric methodologies are implemented, including linear regressions and Markov-type regime-switching models, to capture the interrelationships between interest rates and expected depreciation. The results reveal the existence of regime shifts in the relationship between the interest rate spread and depreciation, with the model being more consistent with the IRP in contexts of high financial volatility. However, during periods of lower uncertainty, significant deviations from parity emerge. This finding suggests that interest rate differentials can be useful as indicators, especially during times of high volatility, and highlights the need to adapt the Central Bank’s intervention strategies in line with changing market dynamics. (Abstract and audio: Department of Economic Publications)