The International Fisher Effect: Theory and application

This paper uses an asset pricing based approach to derive an international version of the Fisher effect, denoted the International Fisher Effect, and tests it for the US and the UK interest rates and inflation rates differentials. We apply the casewise bootstrap technique that is robust to heteroscedasticity and non-normality, which usually characterize financial data. We also allow for a structural break in October 1987 in our estimations. The results show that the international Fisher effect is slightly less than unity. This means that nominal interest rates differential responds less than point-for-point to the changes in the inflation rates differential. The implication of this empirical finding is explained in the main text.