Currency and Yield Co-Integration between a Developed and an Emerging Country : The Case of Turkey

The relationship between currencies and interest rates of different maturities is examined in the Turkish-US context. The real exchange rate between the new Turkish lira (YTL) and the US dollar is found to depend on both short- and long-term real US-Turkish interest rate differences. Cointegrating regressions generate negative and significant coefficients for long-rate differential, consistent with uncovered interest parity and the expectations hypothesis. On the other hand, positive coefficients for real short-term rate differential reveal the forward premium puzzle and the failure of uncovered interest parity for short-horizons. Results are partly driven by the very different risk characteristics of short-term US bonds and the Turkish currency