Deviations from PPP and UIP in a financially open economy: The Turkish evidence

This paper investigates the interrelations between purchasing power parity (PPP) and uncovered interest parity (UIP) in Turkey using Johansen cointegration analysis for a system containing Turkish and US inflation rates, interest rates, and exchange rate. The results of a structural model obtained by data-acceptable over-identifying restrictions over the cointegration space suggest the existence of two cointegration vectors representing UIP and PPP with proportionality and symmetry conditions, respectively. Consistent with the capital enhanced equilibrium exchange rates (CHEERs) approach, each of the international parity hypotheses is rejected when formulated independently. This is a theory-consistent result for a financially open economy for which equilibrium conditions of asset and commodity markets may not be independent of each other. © 2004 Taylor and Francis Ltd