Why does uncovered interest rate parity fail?

31Oct05

An interesting post (somewhat technical) over at Marginal Revolution that seeks to answer the question: Why does investing in high interest rate currencies continue to outperform? Four answers follow.

As Brad Delong succinctly poses the problem:

This is one of the most puzzling puzzles in macroeconomics: that foreign-exchange speculators are not very good at linking domestic money and bond markets to the foreign exchange market. Not enough money seems to be engaged in betting that a currency with a high nominal interest rates will not decline in value fast enough to make investing in its securities unprofitable. Why not? It’s an easy thing to do.